Advice to the ECB: wait before raising interest rates

The oil price appears to be stabilizing somewhat on the global market. That could change again tomorrow, but for the past two weeks, the price of Brent has fluctuated within a range of $100 to $110. The European gas price also seems to be stabilizing. However, there is a fundamental difference between the oil price and the gas price. The price of oil is more or less the same worldwide. The gas price is strongly regionally determined.

The European gas price has nearly doubled since the beginning of the year – and especially since the attacks by the US and Israel on Iran began. US gas prices have fallen by more than 15% this year! The European gas price is currently more than six times that of the US. This is obviously bad for the competitiveness of energy-intensive industries in Europe.

How much poorer will we become as a country due to the rising oil and gas prices? The Netherlands consumes about 800.000 barrels of oil per day. If the oil price remains at the current level for the rest of the year, we will spend approximately €10 billion more on oil imports on an annual basis than last year. We consume about 30 bcm (billion cubic meters) of gas per year. If the gas price remains at the current level for the rest of the year, that will also cost us nearly €10 billion more on an annual basis than last year. These are rough estimates. The higher prices will likely reduce consumption somewhat. On balance, I estimate that the price increase for oil and gas, if prices remain at the current level, will cost us approximately 1,5% of GDP. And those are just the first, direct effects. Let us hope that the military actions end soon and energy prices normalize again.

It is currently being said that prices will remain high, even if the Strait of Hormuz reopens shortly. This is reportedly due to damage inflicted on oil and gas installations in the region, while repairs would take a long time. I cannot judge whether that is correct. However, I do know that the Gulf States are highly dependent on revenue from oil and gas and that they will do whatever it takes to get the Strait of Hormuz reopened quickly and to repair the damage to their production and transport capacity as soon as possible. Kuwait (approximately 2 million barrels of oil per day) and Qatar (approximately 1,3 million barrels of oil, but much more important as a gas producer) are entirely dependent on transport through the Strait of Hormuz. Iraq can export approximately 1,5 million barrels per day through a northern pipeline of its normal daily production of approximately 3,4 million barrels of oil per day. The UAE produces approximately 2,5 to 3 million barrels per day and can pump about 1,5 million barrels per day via a pipeline to the Gulf of Oman, beyond the Strait of Hormuz. Saudi Arabia has a pipeline from the east coast to the west coast with a theoretical capacity of the approximately 7 million barrels the country exports. However, that maximum capacity cannot be fully utilized immediately, and ships bound for Asia must still pass through Yemen, where the Houthis might make that difficult. For the time being, we will continue to face shortages.

Higher inflation
Statistics Netherlands (CBS) publishes daily prices for motor fuels. The most recent data on the CBS website is for March 23. If petrol and diesel prices remain at the level of March 23 for the remaining days in March, the average petrol price in March will be more than 18% higher than a year earlier, and the diesel price nearly 37% higher. That alone will push our inflation figure for March up by about 0,4%.

Our government is still considering measures to compensate households (and businesses???) for the rise in high fuel and energy costs. If fuel excise duties are lowered, that would naturally temper inflation. We are certainly not at that point yet. A reduction in excise duties is a costly undertaking for the government. When it comes to protecting the most vulnerable households against energy poverty, targeted measures are more efficient than a generic measure such as an excise duty reduction. What complicates this discussion is that our excise duties are so high that prices at the pump are much higher here than in neighboring countries. That causes resentment.

This is more 2008 than 2021/22
During the presentation of De Nederlandsche Bank's annual report, Olaf Sleijpen, the new president of DNB, hinted that the ECB has learned from 2022. At that time, the ECB reacted very late to rising inflation. Now that increased energy prices are set to give inflation a boost again, his remark suggests that an interest rate hike will at least be on the agenda for the next ECB policy meeting at the end of April. However, it is not yet certain that interest rates will actually be raised then.

ECB President Christine Lagarde gave an interesting speech this week in which she discussed the similarities and differences between the current situation and that in 2022. In most media, the conclusion was drawn that the ECB trigger happy is and that an interest rate hike in April is therefore highly likely. Personally, I found her speech quite balanced, and I am certainly not yet convinced that the ECB will actually raise interest rates in April. I also actually think that the current situation resembles that of 2008 more than that of 2022. In 2008, the ECB raised interest rates when higher energy prices had pushed inflation to 4%. However, that increase turned out to be a mistake and was quickly reversed. I delve deeper into this in my column appearing on the Investment Officer website on Monday.

Consumer confidence in our country took a hit in March. The index figure as calculated by Statistics Netherlands (CBS) fell from -24 in February to -30 in March. That was the lowest level since September. Naturally, rising fuel and energy prices are the main factor. It is therefore logical that consumer confidence is falling elsewhere as well. Just for the sake of argument, I have included Belgian consumer confidence in the following graph. And naturally, Belgian consumers also became less positive in March. The Belgian consumer confidence index fell even more sharply than ours, but the Belgian index had risen somewhat more before that. The difference in level between the two lines in the graph is insignificant; that is a matter of different scales and axes. The question did briefly cross my mind whether I would rather have Bart De Wever or Rob Jetten as Prime Minister… (rhetorical question…)

Entrepreneurs are not happy about the higher energy prices either. In Germany, the Ifo index fell from 88,4 in February to 86,4 in March. Remarkably, the assessment of the current situation remained stable, but the sub-index measuring expectations plummeted from 90,2 in February to 86,0 in March. Such a large drop in a single month is rare, but it was significantly surpassed after the outbreak of the pandemic and the Russian invasion of Ukraine.

Earlier this week, S&P Global also published preliminary figures for the purchasing managers' indices in various countries. In the eurozone, the purchasing managers' index for the economy as a whole fell from 51,9 in February to 50,5 in March. This was entirely due to sentiment in the services sector. Interestingly, purchasing managers in the manufacturing sector were actually slightly more positive in March: 51,4 compared to 50,8 in February. According to S&P Global's figures, the purchasing managers' index also improved in the German manufacturing sector. This does not align with the Ifo index for the German manufacturing sector, as that sub-index actually declined. I cannot imagine that sentiment in the manufacturing sector will improve if energy prices are rising so sharply. Therefore, for the time being, I attach more value to the message of the Ifo index than that of the purchasing managers' index. To be continued…

Perhaps that improvement in the manufacturing purchasing managers' index is still an echo of the improving global industrial trend. Our CPB publishes monthly figures on the volume of world trade, which are followed by economists worldwide. That is a complex summation of what national statistical agencies publish. The figures are therefore, in my opinion, surrounded by a wide margin of uncertainty, but still. In January, the volume of world trade was 2,0% higher than in December and over 5% higher than a year earlier. That latter figure may be somewhat flattered because 'Lunar New Year' fell very late this year. As a result, January had more working days than last year in countries where the Chinese New Year is celebrated extensively. That should reverse in February. The CPB notes that trade growth in Asia was particularly strong, which points to the positive effect of the shifted holidays. The CPB also reports that Asian countries are increasingly trading with each other.

In a previous weekly, I showed that exports from countries like Taiwan and Korea seem to have exploded over the last few months. I attributed this to the strong growth in investments in artificial intelligence. A former colleague rightly pointed out to me that the export and import figures are nominal amounts and that semiconductor prices have risen sharply recently. However, the CPB figures concern volumes. Rising semiconductor prices are only part of the story.

A friend of mine, an economist living in Asia who focuses on those economies, sent me a few charts this week confirming that there is currently very strong growth in trade in products related to AI. The following chart shows Taiwan's export growth, broken down into IT electronics and the rest. This concerns nominal amounts, and a price effect regarding semiconductors undoubtedly flatters the figures. However, he believes that this applies more to Korea than Taiwan. Here too, I say: to be continued.

Taiwan

For Korea, it looks exactly the same.

South Korea

Closing
The economic outlook remains highly uncertain. We are a net importer of oil and gas. The increased prices imply that we are all becoming poorer. At current prices, I initially estimate this effect at approximately 1,5% of GDP. Pump prices are pushing the inflation rate up by an estimated 0,4% in March.

Prior to the military actions, the growth of world trade accelerated. However, more recent figures show that consumers and entrepreneurs are not becoming any happier.

The ECB's rhetoric is that they have learned from 2022. That suggests that a possible interest rate hike will be discussed at the next policy meeting. Predicting what the world will look like at the end of April is anyone's guess. Because I think the current situation resembles that of 2008 more than 2022, my advice to the ECB would be: just wait and see.

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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