Europe remains an economically weak brother

The US central bank cut the official interest rate by 50 basis points this week. In the last week before this decision, expectations in the market had shifted in that direction, but a cut of 25 basis points would have seemed more logical to me as a first step. More important of course is the question how quickly and to what level the interest rate will be further cut.

My thesis for a while now has been that the official rate is going to come down quite a bit, 250 to 300 basis points between now and the end of next year. In that respect, I got what I wanted. The Fed publishes the Summary of Economic Projections every quarter, a summary of estimates from the members of the policy committee. It showed that the Fed governors themselves are now also expecting a 250 basis point lower rate, although they don’t see the final steps of that process until 2026. That 250 basis points is 100 basis points more than they expected three months ago.

I found Powell's press conference somewhat strange. What is the signal of a first interest rate cut of 50 basis points? Powell emphasized that the American economy is doing well. In doing so, he probably tried to avoid the impression that the Fed is very worried about the economic cycle. According to him, the labor market is also very strong. Unemployment has now risen and job growth has fallen considerably. That development was welcome because the labor market was overheated. But of course you don't want that development to continue much further. Powell was asked what he thought would ensure that the weakening of the labor market would stop now. He didn't really give a convincing answer to that.

It seems to me that we should mainly look at the level of interest rates. These were appropriate for an economy that was growing strongly, where the labor market was tight and that was struggling with high inflation. But the situation has changed. Inflation has fallen sharply and the labor market is no longer tight. In fact, Powell rightly emphasized that the tension on the labor market is now less high than before the pandemic. This does not fit an interest rate that is clearly restrictive, but rather a 'neutral' interest rate. Of course, we do not know how high that 'neutral' interest rate is, but in any case much lower than 5%. It seems to me that the Fed should bring the rate to neutral sooner than 2026. That is why I think that the rate cuts will go faster than the Fed is now projecting. Another 50 basis points of cuts can be expected before the end of this year.

The capital market has of course already anticipated the Fed's interest rate cuts. Since April, the capital market interest rate has fallen by almost 1,0%. The mortgage interest rate has of course also fallen as a result. The American housing market is very interest rate sensitive. The lower interest rate will give the housing market a boost. The first graph suggests that a significant increase in the number of mortgage applications can be expected, although the time to buy a house is still unfavorable due to the combination of high prices and the still relatively high mortgage interest rate.

The American industry is clearly doing better than the European one. In August, production rose by 0,8% month-on-month. Compared to a year earlier, the level was unchanged. In Europe, we are only booking minuses for the time being.

The Dutch consumer is becoming less gloomy. After four consecutive months in which the consumer confidence index fell, September showed an increase. With a score of -21, the index is still well below the long-term average, but the last time the Dutch consumer was less negative was in November 2021. Encouragingly, all components improved, i.e. the assessment of the overall economic situation, the assessment of one's own financial position and the willingness to buy. The consumer felt that the time had improved for making major purchases. I would say: well, consumer, bring it on; 'show me the money!'

In contrast to Dutch consumers, economists and analysts are becoming increasingly pessimistic about the prospects for the European economy. The so-called ZEW index that measures this fell from 17,9 in August to 9,3 in September. That was the third month in a row in which the index fell. This development is partly driven by increasing pessimism about Germany. The ZEW index for the economy of our eastern neighbours fell from 19,2 in August to 3,6 in September. That concerns the expectations. The assessment of the current situation also deteriorated.

However, it seems likely to me that the European economy will grow moderately in the coming quarters. The main factor behind the growth must be the recovery of purchasing power, which will give consumers more to spend.

Closing
Although the Fed surprised me with a rate cut of 50 basis points, the Fed confirmed my view that the rate will be cut significantly in the coming period. This expectation is of course also alive in the market. It remains uncertain how much the American economy will weaken. I think more than what the Fed expects, but it will not be very dramatic.

Europe remains an economically weak brother. Analysts' confidence continues to decline, but Dutch consumers are becoming less gloomy. Hopefully that is a harbinger of stronger growth in consumer spending.

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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