Research

Dutch economy: Further overheating and stubborn inflation

16 March 2023 9:00 RaboResearch

Generous government support and rising wages boosted household spending at home and abroad, and the Dutch economy escaped the mild recession we expected in 2022. The Dutch economy expects to see strong growth this year, at an expected 2.0 percent.

Side view of a man choosing products in a groceries store.

In the fourth quarter, the Dutch economy managed to escape the mild recession we expected last year. It actually grew relatively strongly in the final months of 2022, at 0.6 percent quarter-on-quarter. Indeed, a dip in household spending that we had expected, given high inflation, did not materialize. Consumption actually rose remarkably fast in the last quarter. Rising wages, one-off benefits and government support, such as the EUR 190 per household in November and December, probably played a role in this. In addition, Dutch products proved as popular as ever across the border, as the trade surplus with foreign countries also increased sharply in the final months of the year.

Taken together, economic growth in 2022 totaled 4.5 percent. Economically, the Netherlands emerged from the pandemic significantly stronger than many other countries. Germany, Spain and the United Kingdom, for example, are still struggling to catch up with the (greater) corona damage, let alone return to their pre-pandemic growth path. This can also be seen in GDP per capita: People in the Netherlands earned a lot more income at the end of 2022 than they did at the end of 2019, while in most major European countries, people are still substantially poorer than before the pandemic (see Figure 2).

Figure 1: Economic forecasts

Figure 2: GDP per capita far from being restored everywhere

Source: OECD, Macrobond, edited by RaboResearch

The Dutch economy remains severely overheated, with staff shortages still the most frequently cited obstacle in three-quarters of business sectors. Moreover, there will not be much relief for businesses as we expect unemployment to rise only slightly, from 3.5 percent in 2022 to 3.8 this year and 4.1 percent next year.

Nevertheless, we still expect a relatively strong GDP increase of 2.0 percent for this year (see Figure 3). A higher minimum wage, increased benefits, pensions and allowances, and of course a rise in collective bargaining wages are expected to give household consumption a lurch at the beginning of this year. That purchasing power boost in boom times does mean things will get worse for inflation – which is expected to average 5.0 percent this year despite the energy price cap.

For 2024, we expect relatively limited economic growth of 0.9 percent. Many businesses will struggle to continue growing due to shortages of people, materials and locations, while housing construction is in the doldrums. Rising household consumption and growing business investment will also drive increasing imports of products and services. At the same time, prolonged labor shortages may also be an upside risk to the economy over time. It may encourage companies to invest in innovation and labor-saving measures, potentially increasing labor productivity again after years of practical stagnation.

Figure 3: Growth will come from ...

Source: CBS, RaboResearch

Inflation remains stubbornly high; ECB tougher on inflation

Prices are no longer rising at double-digit rates, but the fight against high inflation is not over. For 2023, we expect an average inflation rate of 5.0 percent (see Figure 4). Thanks to the introduction of the price cap and the sharply lower wholesale natural gas price, energy's contribution to the inflation rate will be negative this year. Meanwhile, high inflation has been widespread. We foresee that this will remain the case in the upcoming period. The government is providing substantial support to the economy, while collective wage growth is expected to rise to an average of 5.6 percent this year. In February, Collective Labour Agreement wages were already 4.9 percent higher than a year earlier. Employers will try to pass on these higher labor costs to consumers by raising their prices. aConsumers are better able to pay these higher prices because of increased incomes. All in all, against the backdrop of a tight supply side of the economy, this is creating price pressure on a broad front of products and services.

We think inflation will remain high in 2024 and assume 4.4 percent. Wage growth also remains higher after 2023 than before the pandemic when wages grew between 1.5 and 3.0 percent. Furthermore, we assume that the administration will continue the price cap in 2024 with higher ceiling prices. Presumably, energy prices in 2024 will be higher than the current ceiling prices, making energy a positive contributor to inflation again next year. Of course, this forecast is surrounded by a lot of uncertainty, as it is difficult to predict volatile oil, gas and electricity prices, and we also do not know exactly whether, and if so, with what measures government will support households and businesses next year.

Figure 4: Inflation not dipping below 2 percent on a sustainable basis for now

Source: CBS, RaboResearch

European Central Bank tightens reins

In response to high inflation, the European Central Bank (ECB) has rapidly raised the deposit rate to 2.5 percent. A 0.5 percentage point increase at the next meeting has already been announced, and several national central bank governors have already hinted that it is unlikely to stop there. These rate hikes are having an impact on the rates that households and businesses pay for their loans (see Figure 5).

Figure 5: Businesses and households pay sharply higher interest rates

Source: ECB, RaboResearch, Macrobond

Higher interest rates are expected to play tricks on the economy for an extended period of time. Changes in monetary policy often have a delayed effect on a variety of economic processes, such as business and government investment, housing construction, housing sales and consumption. Recent data do show that monetary policy is already starting to be felt in the economy. In the ECB’s Bank Lending Survey, lenders in the Netherlands increasingly indicate that they see demand for credit from households and businesses declining (see Figure 6). They also indicate that higher interest rates are playing a more significant role in this. Financial institutions in the euro area as a whole paint a similar picture. When we look at new lending, we see for now only that the total amount of mortgages granted is declining (see Figure 6). Perhaps a factor is that interest rates on mortgages rose earlier than interest rates on business loans and that sentiment among businesses is generally more positive than among homebuyers (see Figure 6).

In the longer term, the rise in interest rates could create more business dynamism. This is important for a healthy economy. In fact, cheap financing has kept outdated, unprofitable companies afloat. With low interest rates, even loss-making companies managed to raise money from financiers last decade. But higher interest rates make banks and investors more critical, forcing weak companies to adapt or disappear. This frees up capital and labor for companies with more prospects. In the long run, this is a boost to the overall labor productivity of the economy.

Figure 6: Lenders feel demand for credit declining due to increased interest rates

Source: ECB (Bank Lending Survey), RaboResearch, Macrobond Note: NFC stands for non-financial corporations. Net percentage is the percentage with a positive response minus a negative response to the question of whether demand for credit by households and businesses increased. Loan data have been transformed to three-month averages. These data are primarily informative as to the direction of credit demand rather than the rate at which credit demand is decreasing or increasing.

Unemployment

The labor market also showed that the Dutch economy is proving more robust than we had expected: in contrast to our previous estimate, unemployment actually fell further in the final months of 2022, averaging 3.5 percent last year. Meanwhile, the share of Dutch people in paid employment rose to a new record and is also high internationally (see Figure 7). We still expect the number of bankruptcies - still incredibly low - to slowly normalize, leading unemployment to also rise slightly. But we are now assuming less of an increase than previously anticipated, as the economic outlook has improved slightly. For this year we assume an average unemployment rate of 3.8 percent, for 2024 of 4.1 percent on average. By comparison, in the previous 20 years, unemployment averaged 6.0 percent.

Figure 7: Fewer hours, but more people

Source: OECD, Macrobond

So it will remain difficult for employers to get staff in the coming years (see also, "Aging population expected to keep labor scarce"). In the longer term, this labor shortage could encourage companies to invest more in innovation and labor-saving technology so that they can meet the growing demand for their products and services despite a shortage of people. This could boost labor productivity, which is badly needed as many workers retire in the coming years and an aging population will put increasing pressure on the labor market. Already almost 16 percent of working Dutch people are employed in health and welfare services. Especially in combination with increased interest rates, the staff shortage is forcing companies to look more critically at their business model.

Consumers spent more than expected

Household consumption grew 0.9 percent quarter-on-quarter (QOQ) in the last quarter of 2022, well above expectations. In particular, households spent more on services – such as culture, recreation, hospitality and transportation. Presumably some households did not use (part of) the unconditional energy surcharges in November and December – 190 euros in both months – to offset the increased energy bill. On an annual basis, household energy consumption fell sharply in the last quarter of last year, and our transaction data show that energy bills did not rise as much as you would expect based on the harmonized consumer price index (see Figure 8). Furthermore, the number of people in work, and thus the number of people with incomes, grew hard in the last quarter of last year. For example, the share of over-45s in paid employment rose relatively hard, and possibly the high labor force participation among Ukrainian refugees also plays a role.

Figure 8: Average increase in energy bill not dramatic (yet)

Source: Rabobank transaction data, RaboResearch

Looking ahead, we have also become more positive about private consumption. For 2023, we assume growth of 2.1 percent, with some of this growth to come from overflow[1] from 2022. We expect most growth in the first half of 2023. The income of a large group of Dutch people increased substantially in the month of January, because of higher allowances and benefits, indexation of pensions, or because they benefited from the large increase in the minimum wage. The other group will see their incomes rise throughout this year due to rising wage growth. Moreover, due to the tight labor market, the risk of (long-term) unemployment currently seems low. Some households also have a mountain of ‘corona savings’ with which they could maintain their consumption.

After a better first half, consumption will grow somewhat slower in the second half of 2023 and in 2024. For 2024, at 0.7 percent, we assume lower growth than in 2023. The boost from support measures is weakening during this year, as the government will hardly take any new support measures in the period ahead. Moreover, in a recent parliamentary letter, the government indicated that support for 2024 will be more austere. At the bottom line, despite generous government support and rising wage growth, many households are left with a cumulative loss of purchasing power in 2022 and 2023. If government support receded, this is expected to weigh on consumption.

[1] For the annualized growth rate, we compare the average level in 2023 with that in 2022. Because consumption and investment grew very strongly in 2022, the levels of these GDP components at the end of 2022 were much higher than average for the whole year. Thus, with that, 2023 also starts at a high level, so even a small increase in consumption and investment during the year already leads to a relatively high average for 2023. To illustrate, suppose consumption in the first quarter of 2022 was at 100, in the second quarter at 200, in the third quarter at 300, and in the last quarter at 400. Average consumption in 2022 would then be 250. Were consumption to remain at 400 in each of the quarters of 2023, the annual average - 400 - would still be much higher than the 2022 annual average.

Headwinds for business investment from increased interest rates and costs

Business investment also performed better than expected in the last quarter of 2022 with a growth of probably 0.4 percent (QOQ)[2]. Businesses have long been a lot more optimistic about the future than households (see Figure 9). We expect business investment to continue growing by 2.6 percent and 0.8 percent this year and next year, respectively. For this GDP component, the overflow effect[3] also provides a more positive picture for 2023 than purely based on quarter-on-quarter growth in 2023.

Business investment will face headwinds from rising operating costs in the coming period. The recent sharp drop in gas and electricity prices provides some air, but this does not eliminate the need for companies to adjust to structurally more expensive energy. Moreover, politicians and employees are increasingly looking at companies to provide wage increases. Increased interest rates also make it more expensive for companies to attract new financing. New investments for which they have to borrow extra money are more scrutinized as a result, and less profitable investments then run the risk of not going ahead. Compared to households, businesses rely more heavily on short-term financing and variable-rate loans.

Nevertheless, we do not expect business investment to plunge. Companies are not entirely dependent on external financing to finance their investments and can also draw on their equity or retain profits. Moreover, many companies face major challenges that require hefty investments, such as security of energy supply and the transition to greener operations. Investments that provide productivity gains, despite higher financing costs, can still be profitable and provide higher returns than other investments, such as savings. Companies that have long struggled to recruit may choose to invest in labor-saving applications. Thus, in addition to being a limiting factor for growth, labor market tightness can also be a source of upside potential.

[2] Total investment excluding residential investment grew 0.4 percent QOQ in the fourth quarter. Business investment made up 80 percent of these investments.

[3] For the annualized growth rate, we compare the average level in 2023 with that in 2022. Because consumption and investment grew very strongly in 2022, the levels of these GDP components at the end of 2022 were much higher than average for the whole year. Thus, with that, 2023 also starts at a high level, so even a small increase in consumption and investment during the year already leads to a relatively high average for 2023. To illustrate, suppose consumption in the first quarter of 2022 was at 100, in the second quarter at 200, in the third quarter at 300, and in the last quarter at 400. Average consumption in 2022 would then be 250. Were consumption to remain at 400 in each of the quarters of 2023, the annual average - 400 - would still be much higher than the 2022 annual average.

Figure 9: Businesses seem more positive than households

Source: European Commission, Macrobond

Government spending

In contrast to that of households and businesses, government consumption in the last quarter of 2022 actually increased somewhat less than expected. With that, government consumption increased by 0.3 percent in all of 2022, after having actually grown strongly in recent years due to additional spending during the corona pandemic. Government investment (think of spending on water, rail and highways, among other things) was actually under strong pressure during the pandemic and continued to decline in 2022, by an estimated 4.4 percent.

However, public investment does seem to be recovering since the summer, a trend that is expected to continue as the government plans to invest more in infrastructure and other areas in the coming years. We therefore expect government investments to grow by 2.9 percent this year and 2.8 percent in 2024. Cabinet-Rutte IV also wants to spend substantially more on, for example, healthcare and defense, so we also assume that government consumption will rise faster. For this year we assume a growth of 1.9 percent; for 2024 we expect a plus of 2.7 percent.

Figure 10: Public debt as a share of GDP back to pre-corona crisis levels

Source: CBS

Consequently, this and especially next year, government spending is expected to contribute strongly to economic growth in the Netherlands (see Figure 3). Financially, there is room for (responsible) government investment. Admittedly, in Q3 the Dutch national debt amounted to almost EUR 451bn, over EUR 50bn more than in 2019, the year before the corona pandemic. But expressed as a percentage of GDP, government debt came in at 49 percent, bringing the debt ratio back to 2019 levels (see Figure 10). This is because the Dutch economy is as much as EUR 130bn larger in nominal terms than in 2019 due to the strong growth of recent years and last year's high inflation.

In our expectations for government spending, we already take into account so-called "under-spending". Apart from the pandemic spending, the Dutch government has not been able to spend as much as planned for some time, partly because of tightness in the labor market. For example, in its Macro Economic Outlook (MEV) 2022, which included the plans from Budget Day 2021, the Netherlands Bureau for Economic Policy Analysis (CPB) still assumed a 1.5 percent growth in government consumption. That ended up being 0.3 percent in 2022. The Budget Day plans for 2023 mean a plus of 3.2 percent for government consumption according to the 2023 MEV, but we already take into account a substantially lower plus of 1.9 percent in our own estimate.

The labor shortage is thus a major downside risk to government spending. In the coming years, unemployment is expected to rise only slightly, making expansion in healthcare or education easier said than done. Moreover, for specific infrastructure and sustainability projects, the lingering nitrogen file remains a stumbling block. Finally, increased interest rates will also weigh more heavily on state finances, possibly leaving less room for spending and investment than initially planned by the government.

Slumping new construction inhibits economic growth

A relatively high number of building permits were granted in 2021, resulting in the highest number of housing completions since 2009 last year: more than 74,000 (see Figure 11). This small rebound in housing construction contributed to a slight increase in housing investment in 2022, the accumulation of housing new construction and renovation, among other things.

The upswing was unfortunately short-lived, however, as by 2022 the number of building permits issued had already plummeted again due to site disputes, nitrogen perils, increased interest rates and subsequent falling house prices. Things went especially hard in the second half of the year: the number of permits issued dipped nearly 30 percent (year-on-year) in the last three months of 2022. Consequently, far fewer homes are expected to be added this and especially next year.

We therefore assume that the housing investment item will shrink significantly, inhibiting economic growth in the Netherlands. We foresee a minus of 2.3 percent this year, followed by a further 7.6 percent decline in housing investment by 2024. Further rising or longer-term high (mortgage) interest rates are a clear downside risk for house prices and thus housing construction, especially given the stubbornly high inflation rate. A faster-than-expected decline in inflation and thus (mortgage) interest rates could actually mean a faster recovery in housing construction. This also applies to possible government plans, for example to give housing corporations more financial and legal leeway to build houses and make them more sustainable.

Figure 11: New construction increases; permits decrease

Source: CBS

Trade surplus grew strongly

Consumers spent substantially more in the last quarter of 2022 than we expected at the end of last year. Businesses also invested more than anticipated. In the last three months of the year, this caused a substantial increase in imports from abroad. At the same time, exports also grew substantially in the last three months of the year, as foreign companies and consumers also kept their hand on their purse strings less firmly than previously expected. This further boosted demand for Dutch goods and services. On balance, therefore, the Dutch trade surplus with foreign countries grew strongly in 2022 (see Figure 12). As in 2021, this item accounted for nearly 30 percent of economic growth. In the annual figure for 2023, trade with foreign countries is also expected to contribute strongly to economic growth, but this is largely due to overflow[4] from 2022. Indeed, growing spending by Dutch households and businesses is actually expected to lead to stronger growth in imports than exports this year and next. Partly because Dutch businesses are barely likely to be able to keep up with domestic and foreign demand due to the tight labor market. In 2024 this will be reflected in stagnation of the (historically still very large) trade surplus.

[4] For the annualized growth rate, we compare the average level in 2023 with that in 2022. Because consumption and investment grew very strongly in 2022, the levels of these GDP components at the end of 2022 were much higher than average for the whole year. Thus, with that, 2023 also starts at a high level, so even a small increase in consumption and investment during the year already leads to a relatively high average for 2023. To illustrate, suppose consumption in the first quarter of 2022 was at 100, in the second quarter at 200, in the third quarter at 300, and in the last quarter at 400. Average consumption in 2022 would then be 250. Were consumption to remain at 400 in each of the quarters of 2023, the annual average - 400 - would still be much higher than the 2022 annual average.

Figure 12: EUR 100bn more expected to be exported than imported this year

Source: CBS, RaboResearch

Table 1: Economic expectations for the Netherlands

Source: CBS, RaboResearch