Recession exaggerated, but economy is ailing

Last week I wrote a column in which I argued that the European economy could be heading for a new recession, while we were actually counting on improving growth. I received quite a few responses to that.

In brief:

• Weak economic figures in the Netherlands…
• ...but European GDP figures better than expected
• Fed leaves interest rates unchanged...
• …although the labor market is weakening
• Dutch inflation is disappointing

The factors on the basis of which an increase in growth was expected remain in full force. The two most important are improving global trade growth and improving purchasing power as wage growth outpaces inflation. However, you should note that the cyclical development is disappointing. Here last week I showed a picture of world trade volume figures, compiled by the CPB. These figures showed that Europe is lagging considerably behind the development of world trade as a whole. The same is evident from figures from RWI and ISL (two German institutions) that register container transhipments in ports. The picture below speaks for itself. Of course you may wonder why the European economy is so much weaker than the rest of the world.

It is not yet apparent in the Netherlands that the improvement in purchasing power leads to stronger growth in consumer spending. This week, CBS published figures on retail sales in our country in June. That turnover was 0,7% lower than a year ago and 1,0% less turnover was generated in volume. You wonder what the consumer is waiting for. What is not, of course, can still come.

Dutch industrial entrepreneurs are not getting any happier now. This week, both the CBS index of business confidence in industry and the NEVI purchasing managers index fell in July. The latter has now dropped below 50.

The GDP growth figures for the eurozone for the second quarter were not even disappointing. In fact, they weren't too bad. According to initial calculations, the eurozone economy grew by 0,3% compared to the first quarter, equal to the growth in the first quarter. And with four quarters in a row of 0,3% growth, you end up with approximately 1,2%, which is not bad for the eurozone. However, there are major differences between countries. The German economy shrank 0,1%, the Spanish economy grew by 0,8% (quarter-on-quarter). It raises the question whether there is a specific German problem or whether there is a broader problem. Dutch GDP figures for the second quarter will follow on August 14.

What remains of my suggestion that we are heading for a recession? Maybe that was too heavy. The increasing world trade and improving purchasing power are not disappearing. These will at least put a floor under the European economy. But many recent figures are disappointing. Above all, I think that we are making things difficult for ourselves in Europe by taking all kinds of measures that reduce growth dynamics. And we want to solve that through expansionary fiscal policy and very low interest rates. It worries me that the insight that we are causing the structural problems ourselves is hardly recognised.

American economy weakening
The Fed left interest rates unchanged this week, although chairman Jay Powell indicated that the labor market is weakening. It is a matter of semantics, you can also say that the labor market in the US is relaxing or that it is 'becoming better balanced'. And all those qualifications are correct.

According to the JOLTS report, the number of vacancies continues to decline. In March 2022, 12,2 million vacancies were counted and in June 2024 the counter stood at 8,2 million. The number of vacancies per 100 unemployed people has also fallen sharply. As the following graph shows.

The number of applications for unemployment benefits reached 249.000 in the week of July 22. That was the highest number since August last year. While these numbers are volatile, it is clear that the trend is upward. That trend started after April. It must be said that a similar development occurred last year that did not last.

A look at the number of ongoing unemployment benefits may provide some more insight. The next picture shows that this number fluctuated around 1,8 million for a year, but that an increase has started since May and that we are moving towards 1,9 million.

That's really not a drama, but it does indicate a weakening of the American economy. This was confirmed this week by the purchasing managers index of ISM (Institute for Supply Management). The industry index fell from 48,5 in June to 46,6 in July, the lowest level this year. By the way, the purchasing managers' indices in China also showed a weakening in July.

You can win, lose or draw
This week there was something for everyone when it came to central bank interest rate decisions. The Bank of Japan raised rates, the Fed left rates unchanged and the Bank of England cut rates.

Fed boss Powell made it clear that interest rates will be lowered if the upcoming inflation figures do not disappoint. At the press conference he was asked several times why interest rates have not been lowered this week. There was no convincing answer to that. Powell said the policy committee still needs a little more confidence that inflation will turn out well. He also said that the current interest rate level is clearly restrictive. And that would have been an argument for adjusting the interest rate, because even after a reduction of 0,25%, the level is still restrictive.

The only reason I can think of for the Fed to wait is that inflation suddenly rose again at the beginning of this year. People probably don't want to run the risk of being confronted with unpleasant surprises again. Because the Fed completely miscalculated the increase in inflation in 2022, its reputation, or in other words, its credibility, has been damaged, which now needs to be repaired.

An interest rate cut by the Fed in September seems a certainty. The more interesting question is at what pace the Fed will further lower interest rates. If the economic slowdown continues and inflation comes under control, things could go fast.

Together or divided?
A very notable difference between the major central banks at the moment is their internal unity or division. The Fed's decision to leave interest rates unchanged was unanimous. The interest rate cut by the Bank of England was spot on. Five members of the policy committee voted in favor of the interest rate cut, four were against. From statements made by ECB directors, I deduce that there is division within the ECB. Perhaps there is also within the Fed, but then they successfully close ranks to the outside world, which benefits their credibility.

Unpleasant inflation surprise
Our inflation rose unexpectedly sharply in July: from 3,2% in June to 3,7% in July. The month on month increase was 1,5%. Since December, the price level has risen by more than 4%, although it should be remembered that these figures are not seasonally adjusted and that most inflation in our country occurs in the first seven months of the year. That certainly does not make a decline in inflation in the remainder of the year any easier. In the last five months of 2023, the price level fell by a total of 0,6%. The year-on-year inflation rate will therefore only fall if the price level falls by more than 0,6% over the next five months. Maybe not impossible, but the likelihood seems limited to me. Companies are still confronted with higher (wage) costs and may still be able to pass on most of these.

According to Statistics Netherlands, rents and tobacco taxes were the main culprits of this high inflation. Unfortunately, CBS will only publish the full details next week.

Inflation was not too bad in the rest of the eurozone, but our figures were clearly worse than elsewhere. For the eurozone as a whole, inflation rose from 2,5% yoy in June to 2,6% in July. Core inflation remained unchanged at 2,9%. This means that inflation is still above the ECB's target, although the difference is not very large. The hawks within the ECB will use the inflation figures to prevent further interest rate cuts for the time being. I suspect that the pigeons will eventually get their way and that a second interest rate cut may be implemented as early as September, but certainly before the end of the year.

Closing
The strengthening of economic growth in our country is not yet going smoothly. Retail turnover and producer confidence are disappointing. Exports are also disappointing. Nevertheless, the improvement in purchasing power and stronger world trade can provide an impetus.

Elsewhere in Europe, with the exception of Germany, things are going better. Economic growth in the eurozone in the second quarter was somewhat stronger than expected. Spain in particular recorded good growth figures.

The American economy is also weakening. This was especially clear this week from figures on the labor market. Yet the Fed left interest rates unchanged. She did, however, more or less announce a first interest rate cut in September. I think more interest rate cuts will follow soon after that.

Inflation remains above the ECB's target. The inflation figure for July was slightly disappointing for the entire eurozone. The Dutch inflation rate was even disappointing, mainly due to rents and tobacco taxes.

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.