How soon will the Netherlands be out of recession?

Our Gross Domestic Product (GDP) has now contracted for two quarters in a row. The Central Planning Bureau (CPB) predicts recovery in the second half of the year. I have yet to see that, because capital market interest rates are rising and the outlook for world trade is unfavorable. This is because the Chinese recovery is definitely not getting off the ground. Finally, the Russian central bank raises interest rates sharply.

Our economy also contracted slightly in the second quarter: -0,3% quarter-on-quarter after a contraction of 0,4% in the first quarter. According to the rule of thumb that an economy that shrinks for two quarters in a row is in recession, we can therefore speak of that. Year-on-year there is now also a minus. Private consumption and foreign trade in particular were the causes of the contraction. Consumption fell by no less than 1,6% and exports by 0,7% compared to the previous quarter. Investments still grew by 1,3%, but that too was weaker than the +2,7% of the first quarter.

This has been a mild recession so far. The labor market remains tight. Although unemployment rose slightly in July: 3,6% compared to 3,5% in June, this was due to more people entering the labor market. The number of jobs increased slightly.

In the draft MEV (Macro-Economic Outlook), the CPB predicts that our economy will grow by 0,7% this year. This will require the contraction in the first half of the year to turn into slight growth. Honestly, I don't see that happening yet. Wage growth outpaces inflation, increasing purchasing power. World trade remains weak and interest rates continue to rise.

China's strong recovery fails to materialise
World trade is depressed by the lack of a strong recovery in China. In July, industrial production was 3,7% above the level of a year earlier, but that is meager for China. In June it was still 4,4%. Chinese consumers are also failing. Retail sales in July were only 2,5% higher than a year earlier. In June it was 3,1%, but rates close to 10% were common in the years before the pandemic. Unemployment rose from 5,2% in June to 5,3% in July. It is writing on the wall that China's statisticians have stopped publishing figures on youth unemployment. It had risen to 21,3% in June. In addition, some real estate companies have run into problems (again). I see more and more pessimistic analysis and comments about China.

The world economy depends on China and, of course, the countries in the region completely. The figures on Singapore's exports are therefore also significant. This is of course a relatively small economy, but very open, sensitive to international trade and certainly to developments in China. The following picture shows that Singaporean exports are falling sharply. Although Singapore is far from our bed, that is not a good sign for us either.

Capital market interest rates are on the rise
As mentioned, rising interest rates are not helping the economy either. Capital market interest rates have risen considerably less than the official interest rates of the central banks. But in recent weeks, capital market interest rates have also started to rise considerably. In the US, the 10-year yield has now risen above the October/November level of last year. This is the highest level since just before the financial crisis. Our capital market interest rates have also risen.

High interest rates put downward pressure on spending. Naturally, some sectors are more interest-rate sensitive than others. The housing market in particular is interest-sensitive. In the US, the link from interest rates to the housing market is very fast and strong. The next picture shows confidence among homebuilders and mortgage market interest rates (on an inverted scale so that a fall in the line represents a rise in interest rates). Confidence has been on the rise since the start of the year, as interest rates did not continue to rise. In August, the confidence index of the National Association of Home Builders fell again, no doubt because of the rise in mortgage rates. I must say that the American consumer is not yet discouraged. Consumption continues to increase steadily.

Inflation has fallen recently and I have written many times that this trend will continue for some time to come. I have also written before that the fall in inflation is partly due to temporary factors. It's useful to see what's in the 'pipeline'. Import prices are such an indicator. They are usually ahead of consumer prices. In July, US import prices increased by 0,4% compared to June. The next picture shows that deflation in import prices is declining. There is still a decline year-on-year, but the road seems to be on the rise. This will eventually reduce the depressing effect on consumer prices. Therefore, after a fall in inflation, we should expect some increase again in the coming months.

Weakening ruble and rising inflation
The Russian central bank this week raised the official interest rate from 8,5% to 12%. Interest rates had already been raised less than a month ago: from 7,5% to 8,5%. The reasons for these actions are the weakening ruble and rising inflation. Paradoxically, these are the result of the better-than-expected development of the Russian economy over the previous year.

When the war broke out, the ruble fell sharply. The central bank raised interest rates sharply and also managed to stabilize the ruble by introducing restrictions on international capital movements. In fact, it recovered strongly. Because we wanted to export much less to Russia, a large surplus was created on the Russian trade balance. That supported the ruble. But now imports are rising again as the Russians find other suppliers and the growth of domestic demand, while production capacity is damaged by the war. For example, the surplus on the trade balance has more or less disappeared and with it the support for the ruble has disappeared. It will be a hell of a job for policymakers to bring and keep the economy in calmer waters.

Closing
Our economy has shrunk for two quarters in a row and, according to economists' rule of thumb, we are in recession. Everyone calls the recession mild and the CPB predicts a recovery. Hopefully they are right, but rising capital market interest rates and the weakness in world trade are significant headwinds. The problems in the Chinese economy are proving to be bigger than expected and the recovery is not getting off the ground. I am therefore not immediately convinced that we will get away with a contraction of two quarters.

While it is reasonable to assume that inflation will continue to fall for some time to come, we should realize that some of the depressing factors are temporary. For example, the fall in import prices in the US seems to be over. Lower import prices can be seen as 'disinflation in the pipeline'. So it will disappear. After a fall in inflation over the coming months, we should therefore count on some increase afterwards. How powerful it is is still very uncertain.

The Russian central bank has raised interest rates for the second time in a month. In doing so, it is responding to rising inflation and the weakening of the ruble, two developments that can reinforce each other. There is a good chance that Russian interest rates will continue to rise. Pressure on the economy and challenges for policymakers are increasing.

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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