Take it easy with those interest rate cuts

In economic terms, this year should be a mirror image of last year. Then economic growth in the US consistently exceeded expectations while the European economy stagnated. In the Netherlands we even recorded three quarters of contraction. The Chinese economy also disappointed.

But this year it will be different. In China, government measures and our rising purchasing power should lead to an acceleration of growth. In the US, things should go the other way this year as the impetus from fiscal policy disappears and high interest rates become increasingly biting. That mirror image does not yet unfold very convincingly, but here and there it starts to look like it.

The business confidence of American entrepreneurs in the industry unexpectedly weakened in May. The ISM index for the sector fell from 49,2 in April to 48,7 in May, the lowest level in a year. The sub-index for new orders even went from 49,1 to a measly 45,4. On the other hand, entrepreneurs in the service sector became more optimistic: 53,8 in May, the highest in eight months, compared to 49,4 in April.

The number of vacancies decreased further in April. More than two years ago there were more than twelve million unfilled positions in the US, now just over eight million. The labor market is therefore relaxing. This is also reflected in the number of vacancies per unemployed person. At the top there were two, now it is 1,25. This corresponds to the proportions before the pandemic.

Finally, US GDP growth in the first quarter was a modest 1,3% (quarter-on-quarter, annualized), the lowest in almost two years. The Atlanta Fed GDPNow (a variable that attempts to measure the growth rate in the current quarter real-time to reflect) for the current quarter currently stands at 2,6%, but a few weeks ago it was still 4%.

In Europe we see somewhat higher growth. Here, economic growth in the first quarter amounted to 0,3% quarter-on-quarter; which annualized, just like in the US, is 1,3%. But that European 1,3% was actually the highest quarterly growth in almost two years.

It is really not very convincing at all in Europe. Take our own country. According to Statistics Netherlands, the volume of household consumption in April was only 0,6% higher than a year earlier. This does not hold in view of the improvement in purchasing power. It is not clear to me why consumption is not picking up more.

Germany is clearly the weakest link of the major countries in Europe. The industry in particular remains under pressure. In April, the volume of new orders fell again: -0,2% compared to March. Those looking for bright spots can note that excluding 'large orders' there was an increase of 2,9%. But yes, Germany has some industries where large orders make the difference. Industrial production fell by 0,1% in April compared to March. Both order intake and production lagged behind expectations and in the case of orders, the March figure was also adjusted downwards.

Chinese exports unexpectedly picked up strongly in May. The export value measured in dollars was 7,6% higher than a year earlier, an improvement compared to +1,5% in April. The statisticians explained the high rate of increase by a base effect (May last year was a weak month) and also by stronger demand from abroad. The global pattern is clearly reflected in the geographical distribution. Chinese exports to the EU fell by 3,9%, those to the US rose a modest 0,2%, while exports to countries in the own region grew sharply. Exports increased by 10,8% to Hong Kong, 9,7% to ASEAN countries and 8,5% to Taiwan.

Despite stimulus measures from the Chinese government, domestic demand remains weak. As a result, import value growth also remained low: +1,8% year-on-year in May. Here too, there is a big difference between the various regions. Imports from the own region grew strongly: Korea: 12,9%; Hong Kong 12,4%; India 11,3% and Russia 6,9%. Imports from the US and the EU actually fell in value, by 5,8% and 5,6% respectively.

The ECB has, as expected, lowered interest rates by 0,25%. It was striking that the ECB actually increased its forecast for inflation. It was also striking that one member of the policy committee had voted against the interest rate cut. That was Robert Holzmann, the president of the Austrian central bank.

During the press conference, bank president Christine Lagarde kept her cards close to her chest regarding possible next interest rate steps. The ECB remains data dependent according to her. I'm betting on another interest rate cut in September. By the way, Canada's central bank also cut interest rates this week. The Bank of Canada was the first major central bank to cut interest rates. The ECB the second.

I would like to add that in my opinion inflation has certainly not yet been overcome. Earlier this week I had the opportunity to address a group of entrepreneurs in Heerlen, an annual pleasure. When I said that the logistics disruptions of the pandemic era have largely disappeared, I was rightly pointed out that international freight prices have risen sharply again recently. Rising transport costs played a prominent role in the inflation process from mid-2021 onwards.

Closing
I have been amazed for some time now by the strength of the American economy. But now some cracks are appearing in that beautiful picture. Things are improving in Europe, but this does not yet apply to German industry or Dutch consumers.

Chinese exports are picking up due to stronger demand from abroad, especially from their own region. Chinese import figures are weak because the domestic economy continues to struggle.

Finally, the ECB has cut interest rates, as expected. That decision was not unanimous, even though there was only one 'apostate'. The interest rate cut was decided despite an increase in the inflation estimate. It does not appear that the ECB will cut interest rates again at its next meeting. Although only one member of the policy committee was against the interest rate cut, I think there is great division within the ECB. I maintain that inflation has not yet been overcome, so I would take it easy with those interest rate cuts.

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

© DCA Market Intelligence. This market information is subject to copyright. It is not permitted to reproduce, distribute, disseminate or make the content available to third parties for compensation, in any form, without the express written permission of DCA Market Intelligence.