Debt-crippled Dutch wake up to housing crash

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Amsterdam, The Netherlands

The Netherlands - home to the most indebted households in the euro zone - is undergoing a severe housing correction which will further dampen consumer spending and extend the country's recession, according to Michael Taylor, an economist at Lombard Street Research.

"Going Dutch", a term used to indicate that each person pays for himself, may be associated with frugality. But recent data shows that households in the Netherlands have been anything but frugal.

The country has the highest total household debt-to-income for the seventeen countries that share the euro, according to Eurostat. At more than 250 percent, it far surpasses the same figure for Ireland, Spain and Portugal.

Surging house prices in the country have now given way to a "painful post-bubble adjustment", Taylor said, similar to the adjustments in Spain and Ireland.

"The Dutch housing bubble was not caused in the main by inappropriately low interest rates following euro membership as occurred in Spain and Ireland. Instead generous tax relief on mortgages fueled a prolonged period of strong demand that pushed house prices to extreme levels," Taylor said in a research note on Monday.

"Any revival in external demand will almost certainly not be strong enough to lift the economy out of recession."

Home prices are nearly 10 percent cheaper in June than a year ago, Statistics Netherlands said on Monday. The price drop is more substantial than in the preceding month when house prices fell by 8.2 percent.

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This is particularly bad news for the short-term consumer outlook, Taylor said, adding that this deleveraging by the household sector will exert a strong downward influence on consumption and the wider economy.

The Netherlands economy has contracted in seven out of the last eight quarters and consumer spending has been in an almost continuous decline for two years now. Household spending on goods and services was down 1.8 percent in May 2013 from May 2012, according to the latest data from Statistics Netherlands, with spending on durable goods falling dramatically.

The chart above shows that declining consumer spending has been correlated with falling house prices in recent years.

But despite the data, yields on the country's benchmark 10 -year sovereign bonds remains below 2 percent and Netherlands still has a 'AAA' rating from Fitch, albeit with a negative outlook.

"The Netherlands is in the midst of a prolonged balance sheet recession. Output is likely to continue on a declining trend at least until house prices stabilize, but there is little prospect of this on a 12 to 18 month view," Taylor said.

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"The advantage the Netherlands has over some other members of the euro zone is that it is well-placed to benefit from a recovery in external demand. Unfortunately any such revival will not be sufficiently strong to lift the economy out of recession. GDP (gross domestic product) is likely to contract by between 1 percent and 1.5 percent this year."

—By CNBC.com's Matt Clinch. Follow him on Twitter @mattclinch81.