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Euro zone rate makers are growing concerned about a clear disconnect between a seemingly booming job market and signs of economic stagnation.
Unemployment in the region is at record lows and businesses are struggling to fill vacancies. However, the eurozone economy has suffered a moderate contraction over the past two quarters.
The disconnect between the strength of the job market and the weakness of growth lies in declining worker productivity, which contributes to inflation at 5.5%, too high for rate-setters’ liking.
European Central Bank hawks want to avoid the fate of Britain, where a tight labor market is exacerbating higher inflation than in the eurozone. They want borrowing costs to rise even more, even though they have already raised the benchmark deposit rate by 4 percentage points to 3.5%.
ECB President Christine Lagarde has warned that monetary policy will need to become more restrictive unless firms “absorb” the costs of lower productivity.
But some economists believe further interest rate hikes could kill jobs without making a big impact on prices. So what conclusions should the ECB make on the labor market ahead of its next monetary policy meeting later this month?
people are working less hours
On the surface, the Eurozone job recovery is almost as impressive as the US.
Data released last week showed the eurozone’s unemployment rate remained at a historic low of 6.5% in May despite the flattening economy. Vacancy rates have fallen slightly from post-pandemic highs, but labor shortages remain widespread and companies are eager to hire, according to business surveys.
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However, the average number of hours people work is declining, even as the number of jobs increases and the proportion of full-time workers increases.
This may reflect an increased preference for leisure as the disruption caused by the COVID-19 pandemic has caused people to reconsider their priorities. RBC Capital Markets’ Peter Schafflik said the reduction in working hours “reflects a lasting change in behavior.” . . It is unlikely that it will be overturned. ”
Worried that it would not be easy to rehire workers when the economy recovers, the ECB suspects that it is closely related to worker hoarding, where companies cling to workers even when business is stagnating. there is
Either way, companies will need to hire more people to keep output constant. This could mean that interest rates need to be raised and kept high for a long time to curb wage pressures.
Most of the job growth is in less productive sectors
The ECB is looking at another factor that could explain the divergence between jobs and growth. Most of the job creation takes place in the public sector, where working hours tend to be short, and in the service sector, where productivity tends to be low. in the industry.
This is particularly noticeable in Germany and Spain, where surges in employment in health and education are offsetting weak private sector demand.
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Any permanent shift from private sector jobs to the public sector would mean lower productivity in the long run.
Some economists share the view that the downward trend in productivity will continue.
Goldman Sachs economist Alexander Stott said the recent decline was “permanent in nature, at least to some extent, and is reflected only slowly in wage agreements.”
Recovery may be more fragile than it looks
Other economists argue that if the ECB raises rates too high, it risks needlessly destroying much-needed jobs in the region’s poorer economies. Employment has not yet fully recovered from the 2008 financial crisis in many job markets in Southern Europe.
Nicolas Goetzmann, head of research at Paris-based asset manager Financière de la Cité, said the record employment levels gave the illusion of strength, but there was still a gap between the region’s economic powerhouses. He said a big difference is hidden.
Employment has also fallen in Germany outside the public sector, he said. Private sector employment growth was led by France, largely due to a surge in apprenticeships backed by government subsidies.
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“There are no fairy tales about the eurozone and jobs,” Mr. Goetzmann said, adding that companies hoarding labor could quickly turn to layoffs if economic conditions worsen. “It’s scary now that the ECB is fighting so hard against domestic demand…to break through a labor market that is starting to improve a bit for the first time in 40 years.”
Eric Nielsen, chief economic adviser at UniCredit Bank, said the ECB’s own projections show wages will barely keep up with prices, measured from the onset of the inflation shock. “We are still in the water,” he said. He added that wage increases have been mostly in Northern Europe, so there has been a much-needed rebalancing in the eurozone as well, which will help southern Europe compete.
Wrong indicator?
Even if the ECB’s intuition about productivity and inflation is correct, some say the central bank’s focus is wrong.
The ECB’s focus is on unit labor costs, and Lagarde said a rise in that indicator was evidence that productivity was declining in the face of wage pressures.
The ECB president said the rise in unit labor costs was “the main reason for the recent upward revision of core inflation expectations”.
But economists such as Klaus Wistesen of consultancy Pantheon Macroeconomics say the move is “long overdue”. He said unit labor costs were “the thing that changes the most right before a recession hits.”
“If you set policies based on unit labor costs… 90 percent of the time you’re going to be wrong.”
