The Netherlands – Navigating an Uncertain Economic Outlook
- The first quarter of 2022 started on a reasonably strong footing
- Prior to the Russian invasion, we were moderately positive about 2022, despite growing concerns about the high inflation prints
- However, following Russia’s invasion of Ukraine, we have lowered our growth forecast and increased our inflation forecast
- How the war plays out remains unclear, meaning our forecasts are surrounded by a considerable amount of uncertainty
- Higher than expected price increases and energy rationing could slow down growth further
- Things could also turn out better than expected. For example, we could be underestimating consumer willingness to use recently accumulated savings to compensate for price increases
The first quarter of 2022 started on a reasonably strong footing. Boosted by full order books, producer confidence hovered around all-time highs in the first two months. Industrial production was 0.6 percenthigher in January compared to the Q4 2021 average. Confidence in the retail and services sector began to rise after the government gradually alleviated Covid measures. Meanwhile, the labor market remains tight (see Figure 1). According to UWV, the social security administrator, 82 percent of the labor force is active in sectors where labor supply is tight, compared to just 38 percent at the end of 2020. In spite of their strong position in the labor market, consumers became more downbeat in the first two months of this year, with rapidly rising inflation the most obvious culprit. Consumer price inflation was slightly lower in February than in January, but at 7.3 percent (HICP), it is still high. Energy remains the most important driver, but food prices increasingly leave a mark on the overall index.
Prior to the Russian invasion, we were moderately positive about 2022, despite growing concerns about the high inflation prints. Anti-Covid measures were alleviated at a rapid pace, and the Netherlands looked set for a return to normal, as the economy is already well above pre-Covid levels. Consumption and investments were prime candidates to do the heavy lifting since these components still have room to catch up. But that was all before Russia’s invasion of Ukraine.
Looking ahead, uncertainty about the course of the Ukraine war could have a material impact on the spending plans of consumers and businesses. Dutch producers did become slightly more upbeat though in March although they were less optimistic about future activity. This contrasts sharply with Germany where the Ifo Business Climate Index fell sharply in March, meaning the mood among German businesses deteriorated significantly. Meanwhile, consumer confidence took a nosedive in March, the first major Dutch data release to reflect the impact of Russia’s invasion (see Figure 2). Expectations about the economic and financial situation in the coming 12 months in particular turned sour, fueled by fears of even higher inflation. Consumers are now more downbeat about their future finances than during the pandemic. Previous research by RaboResearch has shown this sub-indicator has more predictive power for future consumption than the overall index.
Growth Down, Inflation Up
We have lowered our growth forecast, following Russia’s invasion of Ukraine and the adverse impact it will have on confidence, supply, and consumer and producer prices. Global supply chains will again be tested following the (self-)sanctioning of Russian exports and disruptions to shipping crucial inputs out of Ukraine. For example, sunflower oil stocks are already almost depleted, hampering the production of certain processed foods. Catch-up consumption and investments in sectors immune to the latest headwinds can, however, act as a somewhat of a counterweight. All in all, we still expect GDP in 2022 to be 3.1 percent higher on average than in 2021. But this is mainly due to a strong carry-over effect from last year. In fact, we expect the Dutch economy will be just 0.7 percent larger at the end of this year than at the end of 2021.
We have also upgraded our inflation forecast to an average of 5.5 percent for 2022. Food prices will rise more than expected, and the contribution of energy to the overall index will be higher for longer. The government has announced income support and tax cuts to soften the blow for consumers. But, whichever way you look at it, supply shocks to low-elasticity import goods (i.e. goods you need to consume) will reduce welfare - whether it’s consumers paying a higher price, firms squeezing their profit margins, or governments racking up debt (amid increasing interest rates) and thereby passing on the bill to future generations. Government attempts to limit purchasing-power loss may also crowd out other spending.
Downside Risks Loom
And things could get worse. Both our inflation and growth forecasts are surrounded by a considerable amount of uncertainty. Prices could rise more steeply than currently expected. For starters, it is still unclear whether Russian energy will keep flowing into Europe – either because Russia ceases exports or because Europe bans Russian fuels. Sourcing energy from alternative suppliers will come with higher costs, and the quantities needed to replace Russian gas may not be available, which will require higher prices to balance the market. Moreover, we do not yet know how long the war will drag on, and the risk of countries potentially circumventing Western sanctions on Russia and incurring secondary sanctions still looms. The latter would see supply chains coming under increased strain, and again, higher prices may be needed to balance markets.
Higher-than-expected price increases could slow growth further. Moreover, if energy from Russia stops flowing into Europe, the Netherlands would need to find alternative supply to boost storage or risk being forced to ration energy next winter. This burden would likely fall on industry so that households and critical enterprises are shielded. The Netherlands is relatively less exposed to Russian gas than other European countries and has the option to reopen the Groningen gas field – although the government repeatedly stressed that this is an option of last resort. Still, given its strong presence in European value chains, the Dutch economy would suffer when more exposed trading partners need to scale down production.
Things could also turn out better than expected. A quick end to the war would improve sentiment and soften the economic ramifications. Moreover, we could be underestimating consumer willingness to use recently accumulated savings to compensate for price increases. The post-Covid bounce in consumption may also prove more vigorous and longer lasting than we currently anticipate.