Hunt for inflation record, but light at the end of the tunnel

Dutch inflation rose sharply in July, as expected. The January 1975 record is approaching, but the pattern of the detail numbers offers some hope. Business confidence in the industry is weakening around the world and the US job market is sending confusing signals. The recession fear for the United States has, however, been pushed back to the future for the time being.

According to the CBS measure, Dutch inflation rose from 8,6% in June to 10,3% in July. The record (I can tell for the last 60 years) stands at 11,1%, which was reached in January 1975. Just maybe we'll break that old record in the next two months. In August and September last year, the price level rose by 0,4% and 0,1% respectively. If we beat those numbers over the next two months, year-on-year inflation will go up. All in all, inflation will gradually decline from October, thanks to base effects. And if energy prices unexpectedly fall, it can even go quite quickly.

Core inflation also accelerated in July to 4,9%. That is a record, but this series does not go back beyond 1997.

I had already announced quite a bit of higher inflation for July. European gas prices rose sharply in July and that quickly affects our energy prices. Electricity and gas were both about 115% more expensive than a year earlier, despite a VAT reduction from 1% to 21% on 9 July. In June this was still about 85%. Rents were another factor of importance. Last year they were more or less frozen. This year they were allowed to be increased to a limited extent in July. Ultimately, the increase was 3,0% year-on-year, from 0,7% to 0,8% in the preceding months back to July 2021. With rents making up about 23% of the inflation basket, that's adding up.

Petrol and diesel got a bit cheaper in July, reducing the year-on-year increase from about 35% to 25%. People have to eat every day. Food prices (11,5% of the inflation basket) are therefore very visible. Food was 12,3% more expensive than a year earlier, compared to 11,2% in June.

Good news on inflation
I dig through the details in a search for good news and with a little good will it can be found. Apart from energy, rent and food, the inflation of goods seems to be stabilizing, while that of services such as hotels & restaurants and recreation & culture is rising even further. Why do I think that's good news? Because that's how the inflation process started. Okay, energy played a role early on. But the first impetus was given because supply and demand for goods became unbalanced. And that was because people started to buy more stuff during the pandemic, while production decreased due to the lockdowns. The fact that the price increase of goods is stabilizing may suggest that supply and demand are rebalancing. The rise in prices for services only started later when the economy reopened, there was an explosion in demand for services, while there was insufficient capacity to meet that demand. But here, too, supply and demand will once again find the balance. There is some light flickering at the end of the inflation tunnel.

Very different cake from the Bank of England
The Bank of England has hiked interest rates for the sixth consecutive time and this time by 0,5%, the biggest hike since 1995. That may seem a little aggressive, but the official rate is still just 1,75% and inflation stood at 9,4% in June. The real interest rate is therefore still very negative. The Bank of England is remarkably outspoken and outspoken. She thinks inflation will peak at 13,3% in October. While wage growth is also accelerating, under pressure from rising prices and the tight labor market, it is lagging far behind inflation. The Bank of England therefore concludes that real net household incomes will fall sharply this year and next, that private consumption must also fall and that a recession is then inevitable. According to the bank, this will start in the fourth quarter of this year and will last a year. That is a different story than we always hear from the ECB. He will undoubtedly argue that the situation in the eurozone is very different, but I am not falling for that.

Everywhere you see cyclical weakening
Wherever you look, you see a weakening of the economy. Business confidence is weakening in many countries. In industry, that picture is the same in most countries. Manufacturing Purchasing Managers' Indices have been falling for months and have fallen below 50 in many countries. I always like to look at Korea and Taiwan, because those are early cyclical economies where market forces are given a fair amount of free rein. In the Netherlands, the NEVI purchasing managers index is also falling, but it is still well above 50.

The confidence of entrepreneurs in the service sector in the different countries shows a mixed picture. In some countries it is improving somewhat, in others it is declining. That difference seems to be mainly driven by the various lockdown regimes. German industry has been grappling with various challenges for some time now. So far, the entrepreneurs have been very satisfied with their order books. The flow of new orders has been deteriorating for some time now and across a broad front.

In the year-on-year comparison, a negative figure has already been registered for four months in a row. In June it was -9,0. There are still enough orders to keep the industry going for the time being, but still.

Production by German industry actually improved slightly in June. The increase was 0,4% compared to May, but the May figure was adjusted downwards. The production level is still slightly lower than a year ago.

US labor market gives confusing signals
As with us, the job market in the US is extremely tense and there is unprecedented labor shortages. Nevertheless, there has been a very gradual relaxation for a few months now. At least, according to some indicators. The number of unfilled vacancies fell again in June. In March there were still 11,9 million vacancies, in June that was 10,7 million. Another hope, of course, in the more than 158 million jobs.

The number of unemployment benefits in the US stood at 260.000 in the last week of July, slightly more than the previous week's 254.000 and significantly higher than the 166.000 at the end of March. These figures also suggest that the US labor market is relaxing, or weakening, if you will. On the other hand, job growth is still very strong. In July, 528.000 jobs were added, much more than expected. Very strong growth occurred in education and health care, as well as in recreation and hospitality. All a sign of the reopening of the economy. Unemployment fell from 3,6% in June to 3,5%. The rate of increase in average hourly wages remained at 5,2%.

summarizing
Dutch inflation rose sharply further in July, as expected. It cannot be ruled out that we will surpass the inflation record of January 1975 in the coming months. However, from October I expect a gradual decline due to base effects, but energy prices could throw a spanner in the works. On the other hand, falling energy prices can push inflation down sharply. In the details of the CBS figures, I see that inflation in goods is stabilizing and that in services is still rising. I think that's positive, because it suggests that the supply and demand of goods are in balance. Services will then take a little longer, as inflation is lagging behind somewhat.

Seeing the urgency to act to curb inflation, the Bank of England has already raised interest rates six times. She is remarkably outspoken with the expectation that the British economy will enter a recession in the fourth quarter, which will then last a year. If that happens, we won't keep it dry. Not because of the economic relations with the UK, but because our economic situation is not that different from that in the UK.

The first week of the month is always the week in which Purchasing Managers' Indices for the newly closed basket are published. The image is uniform. Business confidence in the industrial sector is weakening, more or less everywhere. The picture is less clear in the service sector. In my view, those numbers are still consistent with the prediction that many economies will go into recession in the coming quarters.

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

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