RaboResearch - Economic Research

High inflation keeps a grip on Dutch economy

Economic Update

  • The Russian invasion of Ukraine is leaving its economic mark on the Netherlands
  • Inflation was sky-high in March and April, but real economic data does not yet show strong cooling of the economy
  • The government is facing one financial setback after another. It is likely that new cutbacks or tax increases will be announced soon
  • Inflation peaked in March. We expect it to average 7.7% in 2022 and 4.5% in 2023. Economic growth will be very moderate in the coming quarters
  • If negative risks related to Ukraine or China‚Äôs Covid restrictions materialize, a recession is around the corner
Figure 1: Consumers continue to spend
Figure 1: Consumers continue to spendSource: Statistics Netherlands, RaboResearch

The Russian invasion of Ukraine is not only a humanitarian tragedy, but also leaves an economic mark on the Netherlands. The impact on inflation is particularly striking. It soared in March (11.7%, HICP) and remained high in April (11.2%), mainly due to skyrocketing energy prices. This had a major impact on consumer confidence, which in April reached its lowest level since 1982. Indicators on both the general economy and the personal financial situation of consumers fell to historic lows. At the same time, little is reflected in the real economy as yet: according to an analysis of transaction data from Rabobank, household consumption continued to grow in March (see Figure 1). The latest export and investment figures (February) also show steady growth. Is this the calm before the storm, or are the economic consequences really not that bad? That will probably become clear in the coming months.

Government budget under pressure

At the same time, the government is facing one financial setback after another. Following a court ruling, the government must refund savers for overpaid savings tax. Restoring purchasing power costs more money due to high inflation. In addition, the Senate has pledged to increase the public old-age pension (AOW) and defense spending must also increase. It is likely that new spending cutbacks or tax increases will soon be announced to (partially) compensate for these setbacks. This could put a brake on the economy and may even have a procyclical effect if high inflation does indeed put downward pressure on spending.

Labor market keeps on shining

The labor market is still very tight: in March the unemployment rate (3.3%) fell again and the number of employed people increased. As a result, at 72.0% the net labor force participation rate, is now at the highest level ever. The number of bankruptcies is gradually increasing, but is still well below pre-pandemic levels.

Inflation projections up, real economy stable

Figure 2: Inflation has peaked
Figure 2: Inflation has peakedSource: Statistics Netherlands, RaboResearch

Although inflation has so far exceeded our expectations, we do believe that the peak is behind us (see Figure 2). Energy prices have fallen since their peak in early March, which translates directly into somewhat lower inflation. Unlike in other EU countries, when measuring inflation Statistics Netherlands assumes that all households are paying the current rates on a monthly basis, which is not realistic as many households have fixed contracts. This will frontload some of the future energy inflation. But even taking this methodological issue into consideration, prices are not falling back to the levels of recent years anytime soon. The war in Ukraine and the related sanctions against Russia, as well as other price-inflating effects (such as the role of gas in the energy transition) will almost certainly continue to play a role for at least a few more years. This means that inflation will gradually decline: 7.7% on average in 2022 and 4.5% in 2023. A correction through temporarily very low inflation is not to be expected.

As wages do not fully keep pace with inflation, purchasing power is permanently lower. This must at some point be reflected in the real economy. We therefore expect very moderate economic growth this year and next. This is not only because domestic spending in the Netherlands itself is under pressure, but also that of its major trading partners, resulting in lower export growth.

Low consumer confidence has not yet translated into declining household consumption. In fact, in view of the extremely tight labor market, there is little reason to expect that it will. What is important, however, is what the government ultimately decides on cutbacks and tax increases. So far, the government has been an important constant and is expected to remain so in the coming years. In the longer term, the various compensatory measures may affect economic growth, but in the short term they prevent the economy from falling sharply back into contraction.

Uncertainty larger than normal

For the coming quarters, developments in Ukraine will continue to shape the global economy and in particular the economy in Europe. The duration of the war, possible new sanctions packages and the reaction of the energy markets will determine how long inflation remains high and how economic activity develops. These factors are virtually impossible to predict. In our baseline estimate, we assume that the current situation remains more or less unchanged and that it will remain so for several quarters. In that case, we do not expect a recession, but relatively low growth. If the situation deteriorates, a situation of negative growth is more realistic.

At the same time, the global economy is hampered by China's Covid policy. The Shanghai port congestion in particular is disrupting various global value chains. This can further drive up prices or simply make certain production impossible. As an open economy, the impact on the Netherlands is relatively large. The longer this situation continues, the greater the chance that the Dutch economy will also be hit.

Major uncertainties in themselves cause economic damage. Interest rates and risk premiums go up and the value of investments goes down. It may also deter companies from investing, dampening both current and future economic growth.

On the other hand, we see some upside risks in domestic spending. Despite plummeting consumer confidence, consumers don't seem to be hitting the brakes yet, buoyed by additional savings accumulated during the pandemic. The economy has also shown more resilience and flexibility in the past two years than we could have foreseen. We would like to be surprised again.

Table 1: Economic forecasts for the Netherlands
Table 1: Economic forecasts for the NetherlandsSource: Statistics Netherlands, RaboResearch
Frank van Es
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
+31 6 1082 0318

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