European Central Bank quickly moving towards 'neutral'

The Dutch labor market is relaxing somewhat. At 3,7%, unemployment in September was still historically low and unchanged from August, but the number of unemployed has increased by an average of 2.000 per month over the past three months.

The first graph shows that this increase is mainly due to young people. I belong to the group of the strongest – appropriately shown in the graph with a gray line – and in our country there is not much to see of rising numbers of unemployed.

The dynamics on the labour market seem to be weakening. The number of employed persons has decreased by an average of 13.000 per month over the last three months. There has now been a decrease of that average over three months for three months in a row. This is a fairly volatile figure, but such a decrease was not seen for a long time.

The ECB came with better news. The so-called Bank Lending Survey, a survey that the ECB conducts every quarter among more than 150 European banks, shows that the credit process is strengthening. For the first time in two years, banks are experiencing an increasing demand for credit from companies. The level of interest rates is no longer perceived as an obstacle and a decline in the demand for credit for making investments also seems to have come to an end. Hurray!

At the same time, banks say on balance that they did not tighten their credit conditions in the third quarter. That was the first time in more than three years. This is also good news. Hopefully, these trends can continue in the coming period. After all, that would mean that companies and banks will regain some confidence in the future and increase their activities.

As expected, the ECB cut its official interest rates by 25 basis points this week. I have been saying that the ECB would cut rates at a pace of 25 basis points per quarter, but that at some point it would accelerate that pace. That has now happened. The reason for accelerating the rate cuts is simple. Official rates were raised to a level that would suppress inflation. Inflation has now fallen below target (the September figure for the eurozone has even been revised slightly from 1,8% to 1,7% year-on-year) and the cyclical environment is weak. The current combination of inflation and growth prospects does not allow for restrictive, ‘inflation busting’ rates. Ergo, the ECB is rapidly moving towards a neutral interest rate level, that is, a level that is not restrictive. How high that is, we do not know. I would think that the neutral level for the ECB deposit rate is not above 2%. After three rate cuts, the rate is now 3,25%. I therefore think that at least five more rate cuts, or a total of 125 basis points of rate cuts, are coming. At a fairly rapid pace. I certainly do not rule out that the ECB will not stop at 2%, but will go even further. It could well be that inflation will eventually fall to a level that the ECB considers undesirably low, and the absence of decent economic growth cannot be ruled out either.

Analysts have become somewhat more positive in October about the outlook for the eurozone economy and also for Germany. The ZEW index for the outlook for Germany rose from 3,6 in September to 13,1 in October. For the eurozone as a whole, the index rose from 9,3 to 20,1. It is not entirely clear what this improvement is due to. The ZEW Institute speaks of the low inflation, the interest rate cuts and also the measures that the Chinese government and central bank have taken to stimulate their economy.

While analysts have become somewhat more positive about the outlook, this does not apply to their assessment of the current state of the German economy. The index fell from -84,5 in September to -86,9 in October. In the last fifteen years, this index was only slightly lower for two months at the beginning of the corona pandemic.

China continues to struggle
The Chinese economy grew by 0,9% (quarter-on-quarter) in the third quarter. That was fractionally better than expected and also slightly higher than the 0,7% in the second quarter. At the same time, it is clear that with a quarterly growth of less than 1%, the growth target for the year as a whole of around 5% will not be achieved. Year-on-year growth fell back slightly, from 4,7% in the second quarter to 4,6% in the third.

Chinese industrial production is doing reasonably well. In September, growth accelerated to 5,4% year-on-year, up from 4,5% in August. The Chinese consumer is not really participating yet. Although retail sales growth improved from 2,1% (year-on-year) in August to 3,2% in September, such a growth rate is insufficient. It is not surprising that Chinese consumers remain cautious. Many have invested their savings in apartments, but the real estate crisis is pushing prices down steadily. This has been the case for about three years now. It is no wonder that the government and the central bank are trying to stimulate business activity. Whether they will succeed with the recently announced measures remains to be seen.

Closing
Dutch unemployment remains very low, but the number of employed persons is falling. Although these figures are volatile, it seems that the dynamics of the labour market are currently weakening.

The credit process in the eurozone, on the other hand, seems to be strengthening somewhat. Companies are knocking on the banks' doors a little more often and they are no longer tightening their credit conditions. According to analysts, the outlook for the economy in the eurozone improved somewhat in October, but the situation in Germany remains depressing.

The ECB has stepped up the pace of rate cuts, cutting rates for the third time this year this week. I expect at least five more rate cuts, or rather a total of 125 basis points of rate cuts at a rapid pace. More is also possible.

The Chinese economy continues to struggle. Whether the recently announced measures will game changer are, is far from certain.

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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