Inflation has not yet been overcome

It's not easy being a central banker. Around the turn of the year, the Fed announced that it would begin a process of interest rate cuts if the members of the policy committee had even a little more confidence that inflation would turn out well. It seemed like just a matter of a few months. Then followed a series of disappointing inflation figures. Confidence did not increase and interest rate cuts were postponed.

The Fed met again this week. From the published dotplot shows that four members of the policy committee expect no more interest rate cuts this year, seven are thinking of one interest rate cut and eight are thinking of two interest rate cuts before the end of the year. But before this was announced and while the Fed was meeting, it turned out that inflation in May was actually lower than expected.

During the press conference, Chairman Powell was asked how that good inflation figure had influenced the discussion and expectations. It was not entirely clear whether the Fed had already seen the inflation figure before its own meeting. Powell was vague about it. He said some of his colleagues had made some adjustments to their own projections, while others had not.

Be that as it may, financial markets responded positively to the inflation rate. Bond prices soared, as did stock prices, and the dollar lost ground. I found that response quite remarkable because the windfall in the inflation rate was only 0,1%. Apparently markets were hungry for some good inflation news.

There's no denying that it was quite a nice inflation rate in the US. Other inflation measures also show a moderation in the pace of price increases. Powell also expressed satisfaction that the labor market is becoming better balanced, which reduces the risk of significant wage increases, although he believes the labor market remains strong. So it seems that the Fed is lagging behind the facts. Anyway, if inflation is not too bad in the coming months, then two interest rate cuts are possible this year.

Powell was also asked why the Fed would cut interest rates at all now that economic growth is entirely reasonable and inflation is still above target, although it is going down. The Fed boss responded that the current level of interest rates is restrictive and that the Fed would harm the economy if it were to remain at that restrictive level for too long. I think he's right.

In our own country, CBS published the details of inflation in May. We already knew that inflation had remained stable compared to April: 2,7%. A few things struck me. Labor-intensive services continue to rapidly become more expensive. Rates at hairdressers and beauty salons were 7,4% higher than a year earlier and having household appliances repaired was 9,0% more expensive. Prices in hotels and restaurants have risen 5,7% in one year. You can also see in the relative price movements how the government is trying to steer. Gas was 20,4% more expensive than in May 2023, electricity 25,1% cheaper. That should encourage people to switch.

Products whose prices skyrocketed during the pandemic are now becoming cheaper. For example, furniture prices fell by 3,1% in May compared to April and by 7,1% compared to May last year.

I am surprised about the car insurance premiums. They just keep rising. In May another 6,3% was added. Year-on-year, that figure stands at 22,7%. I had noticed that car insurance premiums had also risen sharply in the US (and perhaps elsewhere). While our premiums rose again in May, they actually fell in the US. Hopefully that is a harbinger for us…

It does not look like there will be a significant decline in inflation for the rest of the year. That is due to the pattern last year. Caution is required here because the figures are not adjusted for the season. Between May and December last year, the price level rose by only 0,15% on balance. For the inflation rate to fall from 2,7% in May, the price level must rise by less than 0,15% in total in the last seven months of the year. That seems like a challenge to me. In July last year, prices rose by more than 1% month-on-month. Perhaps the inflation rate will then drop somewhat, but another setback awaits us in November.

By the way, I am very curious about the inflation rate in July. That is the month in which rents are increased. The maximum rent increase for social housing this year is 5,8% and for other homes 5,1%. Last year it was 3,1% and 4,1%. According to Statistics Netherlands, rents then increased by 2,0%. Rents are important, because actual rents and rents attributed to homeowners together have a weight of about 20% in the inflation basket.

The economic situation in our country appears to be slowly improving. Production in the manufacturing industry rose by 0,4% in April compared to March, although the level was still 3,5% lower than last year. Exports also improved in April. The volume of our goods exports was 2,3% higher than a year earlier. It was the best figure since March 2023. In particular, more machines, chemical products and food and beverages were exported.

Closing
Actually, the immediate future looks quite reasonable. The economy is picking up. The first sign that we are benefiting from a strengthening of world trade can be seen in the export figures for April. Many companies are still consuming inventories. That depresses growth, but is temporary. When stock taking makes way for stock building, production growth actually gets a boost. Furthermore, there has been a clear improvement in purchasing power this year, which is supporting private consumption.

The latest US inflation figure was a windfall. The financial markets were also ready for this after a series of setbacks. If the coming figures are also better than expected, the Fed may cut interest rates a little faster than it currently seems to be planning. But let's not celebrate too early. Inflation has not yet been overcome. You can see that in our own inflation rate. At 2,7%, this is clearly above the 2% target that the ECB applies for the entire eurozone and it seems unlikely to me that our inflation rate will decline on balance in the second half of the year.

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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