Hooray: food price inflation is finally coming down

Our industry is not doing well, nor is it in Germany. Production in the manufacturing industry in our country fell by 2,0% in March compared to February and by 4,0% compared to March 2022. It was the third month in a row with a decrease compared to a year earlier . Production in the chemicals and rubber and plastics industries did increase slightly compared to February. You can also expect that in these energy-intensive sectors now that energy prices have fallen sharply. Nevertheless, the production level in the chemical industry was still 17,6% (!) lower than a year earlier and in the rubber and plastics industry 9,5%.

The machinery industry was the last year star performer, but through March, production has fallen for five months in a row, with production in March falling to 6,4% below the year-earlier level. Production in the manufacturing industry also fell in Germany in March compared to February: -3,4%. Year-on-year there was an increase in Germany: +1,8%. It was striking that production in energy-intensive sectors in Germany fell in March compared to February: -3,3%. Compared to a year earlier, the production level in these sectors was 13,0% lower. The significant gap that has arisen in recent years between production volumes in Germany and the Netherlands is rapidly closing considerably, as the first graph shows.

German industry is clearly suffering from the weakness of the Chinese economy. China is Germany's most important trading partner. In the first quarter, the value of trade with China was 10,5% lower than in the first quarter of 2022. China's own trade figures paint a mixed picture. In April, exports exceeded expectations, but import values ​​disappointed. It was 7,9% lower than in April 2022. That does not bode well for German industry for the time being.

Hooray: food price inflation is (finally) falling
Last week, Statistics Netherlands had already published its 'quick estimate' of inflation for April. It has increased from 4,4% year-on-year in March to 5,2% in April. The final figures and all details followed this week. The good news is that the rate of increase in food prices has finally slowed down. This stood at 15,9% year-on-year against 18,4% in February and March. The moderation in food inflation is undoubtedly the delayed effect of the fall in energy prices. I expect a further decline in food price inflation.

A moderation in food price inflation has been underway in the US for some time. Incidentally, headline inflation fell slightly there: from 5,0% in March to 4,9% in April. Core inflation also fell a tenth to 5,5% from 5,6% in March. An important part of US inflation is driven by rents. They make up more than a third of the basket and just over 43% of the core inflation basket. Rents were 8,1% higher in April than a year earlier, the same as in March. Rents follow house prices in the US, albeit with a significant lag. Given that house prices have been declining for some time, the rate of rent growth can also be expected to slow down in the foreseeable future. The bond market reacted very positively to the data because inflation apart from rents was very subdued.

In our country, inflation (year-on-year) is likely to rise further in the next two months. This has everything to do with the fact that prices fell in absolute terms in May and June 2022 on balance. They are successively dropped from the calculations, so that a so-called base effect will push inflation upwards unless prices follow last year's pattern, but that seems highly unlikely to me. The opposite is happening in the US. Prices there rose sharply in May and June last year, so that the base effect there will depress inflation figures in the coming months.

Lower inflation numbers will likely prompt the Fed to leave interest rates unchanged at their June policy meeting, after ten consecutive hikes. Various economic indicators may also contribute to the Fed's decision not to raise interest rates further. After all, there is a fairly clear economic weakening. For example, the number of applications for unemployment benefits rose to 264.000 in the most recent week. Such a figure had not been seen for about a year and a half.

Credit crunch is also looming in the US
As in the eurozone, US banks are tightening their credit conditions. This could result in a credit crunch, which will put a considerable damper on the economy. The following picture is based on the Fed's quarterly survey of banks. An observation above zero means that more banks say they are tightening credit conditions than there are banks that are easing credit conditions. The current level of this series invariably coincided with a recession in the past.

As if stricter credit conditions at banks weren't enough, corporate investment plans are also shrinking. The following chart shows the investment intentions of SMEs. They have been falling since October 2021. Nor a good sign for the economic outlook.

US debt ceiling debate nears climax
The moment when the US government can no longer meet all payment obligations is fast approaching. Perhaps a temporary solution will be found that will allow a few months' stay of execution. But it's clearly a very painstaking process where Democrats and Republicans don't give each other an inch of space and hope the other party suffers electoral damage if it ends in chaos. The Democrats want to implement their already adopted budget, but the Republicans are demanding cuts. Otherwise they are not prepared to raise the debt ceiling. It is a kind of blackmail, which incidentally occurs more often in American politics. Incidentally, there is a remarkable development in public finances in the US. The federal deficit has increased rapidly since the middle of last year as the following chart shows. The deficit is now around 7,5% of GDP. That's not the point.

The last picture shows what causes this rising deficit. Expenses are rising sharply while revenues are falling. This is of course not a sustainable trend.

I am concerned about developments in Dutch industry. Production has been falling for a while. Although production in energy-intensive sectors is increasing now that energy prices have fallen sharply, it is certainly not all over. The standout of 2022, the machine industry, is now also showing a series of minuses. The Chinese economic recovery is far from smooth. German trade figures show that our eastern neighbors are still noticing much of the Chinese economic recovery.

Our inflation rose somewhat in April after falling for months. There is a good chance that inflation will rise further in the coming two months, although this is largely due to base effects. In the US it is the other way around. There, inflation fell in April, albeit slightly. Inflation there will continue to fall in the coming months because of base effects. When the rate of increase in rents slows down, inflation will be able to fall considerably further. That's what I think is coming. The bond market will welcome it and the Fed will hold back for now.

In my view, the US economy is weakening. The labor market is gradually becoming less tight, banks are becoming less and less generous with credit and the willingness of companies to invest is declining. The discussion about the US debt ceiling is approaching a climax as the bottom of the treasury is in sight. That can be quite a spectacle. Meanwhile, US government finances are rapidly deteriorating. The budget deficit is now back at 7,5% of GDP. I seem to be the only one looking at it and worried. Am I crazy or are you all crazy?

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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