Netherlands

Oxford Economic Country Briefings, May 29, 2007

Highlights and Key Issues

* Economic growth did not change gear at the start of 2007, with Q1 GDP again expanding 0.6% on the quarter and 2.8% on the year. Growth was driven by booming business investment and renewed buoyancy in exports. Meanwhile, private consumption growth bounced back and climbed by 0.5% on the quarter, having fallen by 0.1% in Q4.

* Inflationary pressures are likely to emerge as a result of rising labour costs. Higher input costs will begin to erode corporate profitability, putting pressure on firms to raise output prices. There has so far been little sign of a pick-up in wage inflation, but core inflation is expected to creep up to 2% by year-end from just under 1.5% in Q1.

* A strong labour market will boost disposable household incomes. This should provide a solid basis for rising private consumption growth. However, the savings ratio is likely to remain stable at about 6.5% this year, as higher borrowing costs discourage households from taking up extra credit.

* Export growth will continue to benefit from a supportive external environment. However, imports are expected to grow at a slightly faster pace due to demand for investment goods and consumer durables. As a result, the contribution of net exports to growth should fall this year but remain positive. The large current account surplus is forecast to fall back to about 8.2% of GDP in 2007 from 8.7% last year.

Overview

Balanced growth seen in 2007...

* Economic growth did not change gear at the start of 2007, with GDP in Q1 again expanding by 0.6% on the quarter and 2.8% on the year. Booming investment, renewed strength in exports and a rebound in consumer demand helped support economic growth, despite stagnating government consumption and strong imports. Moreover, latest survey data suggest that economic activity should maintain its buoyancy over the course of the year, with households and firms remaining upbeat about their financial situation and willingness to spend. As a result, GDP growth is expected to be 2.9% in 2007 and 2.4% in 2008.

...as firms continue to spend

* Fixed investment growth accelerated sharply in Q1, up 2.1 % on the quarter, and strong investment growth should continue over the course of the year. The momentum in private sector business investment is being supported by healthy corporate profits. In addition, capacity constraints in the manufacturing sector - at their highest in five years - and industrial orders growth at a robust 8.2% year-on-year in Q1 indicate that firms need to continue investing in order to expand production. Therefore, fixed investment is projected to rise by around 6.5% this year, similar to last year's increase.

Labour market gains raise wages

* The unemployment rate is expected to continue its downward trend and end the year close to 4.5%, compared to 4.9% in Q1. Employment gains in the services sector are driving the improvement, especially in the business and financial sectors of the economy. In addition, as manufacturing firms increase staffing levels over the year, this is likely to add further momentum to employment, which could rise by almost 2% in 2007.

* Inflationary pressures will start to emerge as a result of rising labour costs, even though there has been little sign of this to date. Moreover, rising commodity prices will also push up input costs and erode corporate profitability, putting pressure on firms to raise output prices. As a result, there is a danger that a modest wage-cost spiral could emerge. However, our projections suggest that core inflation should only creep up to 2% by year-end from just under 1.5% in Q1, but the risks to this forecast are on the upside. However, the impact on headline inflation should be muted due to a moderation in energy price inflation over the coming months. Headline inflation is expected to average 1.8% in 2007, below the Eurozone average, but up on the 1.1% seen in 2006.

A solid pick-up in consumption

* A strong labour market will boost disposable household incomes. This should provide a solid base for rising private consumption growth. Indeed, demand for consumer durables continues to rise rapidly, up 7.6% year-on-year in March, indicating that consumer confidence remains high. However, the savings ratio is likely to remain stable at about 6.5% this year, as higher borrowing costs discourage households from taking up extra credit.

External demand to remain robust

* Export growth will continue to benefit from a supportive external environment. In addition, the improvements in cost competitiveness over the last few years will help increase export market share in the rapidly expanding emerging European and Asian markets. However, imports are expected to grow at a slightly faster pace - thanks to demand for investment goods and consumer durables - so the contribution of net exports to growth should fall this year, though remaining positive.

* The large current account surplus is expected to fall back slightly to around 8.2% of GDP in 2007, having reached a record high of 8.7% of GDP in 2006. This was almost entirely due to an expected euro0.9bn deterioration in the trade balance.