Economic growth slows, inflation remains persistent

Gross domestic product (GDP) growth will pick up further after this year and is estimated at 1.3% next year and 1.1% in 2025. Inflation, which peaked at 11.6% last year, will fall to 4.2% this year and continue its downward path to 3.7% next year and 2.5% in 2025.

Core inflation in particular has been more persistent than anticipated and is now above headline inflation, which includes energy and food prices. We estimate core inflation in the Netherlands at 6.8% this year, 3.6% next year and still at 2.8% in 2025.

As energy prices are now higher, passing through to the prices of almost all goods and services, households are seeing their purchasing power evaporate and are spending less, which slows down the economy. In addition, Dutch export growth is losing steam due to the downturn in world trade. To quell soaring inflation, central banks worldwide raised interest rates. This acts as a brake on the economy, as higher interest rates depress business investment and cool the housing market. House prices in the Netherlands are set to fall by 5.1% this year and another 3.8% next year, followed by a small uptick in 2025. By 2025, we expect house prices to have fallen roughly 10% from their peak of the summer of 2022.

Some cooling of the economy may be beneficial

The cooling of the economy will contribute somewhat to the expected decline in inflation in the years ahead. Nevertheless, actual output (GDP) will remain slightly higher than potential output, i.e. the output that can be sustained efficiently over a longer period of time. Unemployment will rise slightly but remain well below 4%, which is still low from a historical perspective. The labour market will remain extremely tight as a result. Public finances will deteriorate in the coming years. While public debt remains well below the EU norm of 60% at 50%, the budget deficit will edge close to the 3% limit at 2.2% this year and 2.7% in the following years. Given the state of the economy, this makes fiscal policy expansive.

Governments, employers and unions: help fight inflation

The ECB aims for a 2% inflation target in the medium term. Given that actual figures have far exceeded that target, interest rate hikes are needed to bring inflation down. If inflation should fall in the euro area but remains relatively high in the Netherlands, curbing inflation in the Netherlands will be an even more daunting task. After all, the ECB looks at the entire euro area and therefore cannot apply its interest rate policy specifically to the Netherlands. Once the ECB stops raising interest rates, the fight against inflation in the Netherlands will need to be fought mainly by the government and social partners.

Therefore, inflation is most effectively contained when central banks, governments, employers and workers join forces in the fight. Wage bargaining is an essential element in this. Its outcomes depend on sector- and company-specific circumstances, with labour market tightness also playing a role. To prevent the economic adjustment process from causing leapfrogging that pushes inflation further up, businesses and unions need to achieve controlled growth in profits and wages.

Return to fiscal discipline

The Dutch budget deficit will remain only narrowly below the EU norm of 3% in the coming years, which is too high, given the state of the economy. By pursuing such expansive fiscal policies, the government is contributing to overheating, which further complicates the fight against inflation.

Quite apart from the fight against inflation, it is important that public finances remain sound in the longer term. With fiscal policy as it stands, public debt may eventually rise well above the European norm of 60% of GDP. This shows the importance of ensuring that any new purchasing power support measures and new policies are adequately covered financially in the next budget.

Alternative scenario

It cannot be ruled out that wage-price dynamics have a stronger-than-normal impact on core inflation. Therefore, we have elaborated an alternative scenario in which core inflation is assumed to persist even longer. In addition, energy prices are assumed to go up again. In that scenario, inflation ends up 3.1 percentage points higher next year (at 6.8%), and core inflation would average 0.6 percentage points higher in 2024 and 2025 than in our baseline projection (at 4.4% and 3.2%, respectively). Households' purchasing power declines sharply due to high energy inflation and reduced economic activity. Also, unemployment rises more steeply. Economic growth is 0.7 percentage points lower compared with the baseline projection (at 0.6%).

For more information, please contact Bouke Bergsma by email at bouke.bergsma@dnb.nl or by telephone at +31 (0)653 258 400.