European interest is already far too low for the Dutch economy

Very lower but still high. That is the conclusion after the Central Bureau of Statistics on Tuesday in the so -called fast estimate it Inflation figure for the month of May published. With 3.3 percent on an annual basis, it is many tenths of percentage points lower than last month (4.1 percent). In January this year, even inflation simply tapped the 3.3 percent, the rest of the year (and the half year before) it was higher than that.

This time the decrease in inflation compared to the past months was mainly caused by a considerably lower depreciation in the service sector (3.8 percent in May, compared to 5.6 in April). It weighs heavily in a country where the service economy is so important. It also played that many ‘expensive’ vacation days fell in April (Easter and a good part of the May holiday), which then worked praising. That May is therefore now lower is therefore partly a seasonalness.

Also according to the harmonized European definition (inflation excluding the costs for living, such as rent and mortgage), the Netherlands is still on the top of the depreciation of money. Only Slovakia, Croatia, Estonia, Latvia and Greece have higher inflation in the month of May, reported Statistics agency Eurostat on Tuesday morning. On average, inflation throughout the eurozone (twenty countries) last month was 1.9 percent, even slightly below the official goal of the European Central Bank (ECB) of 2 percent.

Gas pedal

That 2 percent is what economists are seen as ‘healthy depreciation’. Central banks adjust their monetary policy to that target inflation: if inflation is too high, the interest rate is increased so that money is borrowing and investing more expensive and the speed goes out of the economy. If inflation is too low, the interest rate is reduced to boost the economy (borrowing money cheaper and therefore investing and consuming).

This Thursday, the ECB board will meet again in Frankfurt for an interest rate decision. The central bankers look at the average inflation level in the eurozone. Financial analysts are already taking into account a further reduction of the most important interest rate with 0.25 percentage point, to 2 percent. That is the lowest level in more than two years and half of the level in June 2024, when the ECB began to lower interest rates.

Within the eurozone, the Netherlands has a relatively much breakdown with the ECB policy

With an inflation that is still far above the target of 2, that is bad news for the Dutch economy. Although inflation will be printed in the coming months because a number of inflation-increasing measures (such as tax and excise duties from a year ago) no longer have any effect on the statistics, but at the same time the ECB has already had the foot on the accelerator for a year. The monetary policy of the ECB therefore does not fit in with the actual state of the Dutch economy.

Painful

That is – unfortunately – a fact in a monetary union with different Member States, but the Netherlands does have relatively much bad luck. In A recent report from the Central Planning Bureau The economists calculate what the interest should be per eurozone member state. This so-called Taylor interest rate, named after the economist John Taylor, who conceived him in 1993, is a kind of ideal interest rate, based on, among other things, the extent to which the actual economic production of a country deviates from the potential production of that economy (the so-called output gap) and the inflation level.

For economies of countries such as France and Italy, with relatively low inflation and an economy that more or less is expected to perform, the current ECB interest rate of 2.25 is nicely close to the ideal interest rate. And with the interest reduction that is expected to follow on Thursday, Italy is even just right.

For the Netherlands that is a completely different story. Inflation here is relatively high and the Dutch economy has been performing better for years than what you can expect based on the capacity of the Dutch economy. The interest in the Netherlands should therefore have a braking effect to reduce inflation, and should ideally be between 4 and 4.25 percent. That is far away from the current ECB interest rate.

The calculations of the Taylor interest rates of the CPB run until the end of 2024, the most recent reduction in Dutch inflation has not yet been incorporated. Nevertheless, it is safe to assume that an ECB interest of 2 percent is really too low for the Dutch economy. The risk that inflation will not fall much further due to that low interest rate is real. Borrowing money becomes cheaper, so that also applies to business and mortgage loans. That money comes into circulation and drives the already excessively performing economy. And then the effects of the Trade War with the US have yet to come: the harder Europe refers to its own import duties (and therefore more expensive import), the greater the risk of increasing inflation.

Painful, but an alternative to the ECB interest rate is not for euro countries. The only thing that a cabinet can do is try to dampen monetary policy with the budget policy. In the Dutch case that would mean: a lot of cuts to in any case in any case inhibit government spending. In any case, the last spring memorandum of the cabinet does not provide for this. And with the display of the coalition and elections, there will be few political parties that will come up with concrete austerity proposals in the coming months. In short, inflation in the Netherlands does not seem to be sworn.

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