Categories: Markets

Is the eurozone’s jobs market as strong as rate-setters think?

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Eurozone rate-setters are increasingly concerned about an apparent disconnect between a seemingly improving job market and growing signs of an economic slowdown.

Unemployment in the region is at a record low and companies are struggling to fill vacancies. But the economy of the eurozone suffered a mild decline in the last two quarters.

The disconnect between the strength of the labor market and the weakness of growth lies in the fall in the productivity of workers, which has contributed to the 5.5 percent inflation rate that remains too high for the liking of the rate setters.

European Central Bank hawks are keen to avoid the fate of the UK, where a tight labor market has fueled higher inflation than in the eurozone. They want further increases in borrowing costs, despite raising their basic deposit by 4 percentage points to 3.5 percent.

Christine Lagarde, president of the ECB, warned that unless companies are willing to “absorb” the cost of reduced productivity, monetary policy will have to become more restrictive.

But some economists believe that large rate hikes could kill jobs without much effect on prices. So what labor market conclusions should the ECB take ahead of its next monetary policy meeting later this month?

People work less hours

On the face of it, the eurozone jobs recovery is almost as impressive as the US.

Figures published last week showed that unemployment in the eurozone remained at a historic low of 6.5 percent in May, even as the economy flatlined. Business surveys suggest that labor shortages are still widespread and that companies want to hire, although the vacancy rate has declined slightly from post-pandemic highs.

However, although there are more jobs, and a higher proportion are full-time, people work fewer hours on average.

This may reflect the growing desire for leisure time after the dislocation of the Covid pandemic has led people to rethink their priorities. Peter Schaffrik of RBC Capital Markets said that shorter working hours reflect a “long-term change in behavior . . . which cannot be reversed”.

The ECB suspects it has more to do with labor hoarding, where companies hang on to workers even at the tail end of business because they worry they won’t be able to hire again when the economy picks up.

Either way, companies need to hire more staff to keep output constant. This in turn means that interest rates will have to rise and stay high for longer, to keep wages down.

Most of the job growth has been in less productive sectors

The ECB draws attention to another factor that may explain the disconnect between employment and growth: more job creation is in the public sector, where working hours tend to be shorter, and in services, where productivity is lower than that. in industry.

This is especially true in Germany and Spain, where a surge in health and education hiring has offset sluggish private sector demand.

If there is a permanent shift to public from private sector jobs, then that means productivity will be lower in the long run.

Some economists share the view that the weak productivity trend will endure.

Alexandre Stott, an economist at Goldman Sachs, said the recent fall would be “at least somewhat permanent in nature and gradually reflected in wage agreements”.

Recovery can be more fragile than it looks

Some economists argue that, if it raises rates too high, the ECB risks unnecessarily destroying the jobs needed in the bloc’s poorest economies. In many southern European labor markets employment has not fully recovered from the 2008 financial crisis.

Nicolas Goetzmann, head of research at Paris-based asset manager Financière de la Cité, says the high employment record gives an illusion of strength, but hides large differences between the bloc’s major economies. .

Outside the public sector, employment in Germany is falling, he said. The growth in private sector jobs is driven by France, largely due to an influx of apprenticeships supported by government subsidies.

“There is no fairytale about the euro area and jobs,” Goetzmann said, adding that companies hoarding workers could easily cut jobs if economic conditions worsen. “It’s scary now that the ECB is fighting so hard against domestic demand . . . to destroy a labor market that for the first time in 40 years is starting to get better.

Erik Nielsen, the chief economic adviser at UniCredit bank, said that the ECB’s own projections show that wages will barely keep up with prices when measured from the start of the inflation shock. “We’re still underwater,” he said. Since salary incomes are mainly in northern Europe, he added, there is also a need for rebalancing within the eurozone, which will help southern Europe to compete.

The wrong sign?

Some say that, even if the ECB’s intuition on productivity and inflation is correct, the central bank is looking at the wrong sign.

The ECB focused on unit labor costs, with Lagarde pointing to the rise in this measure as evidence that productivity has weakened in the face of wage pressures.

This increase in unit labor costs is, the president of the ECB, “a key reason why we recently revised our projections for core inflation”.

But economists such as Claus Vistesen of the consultancy Pantheon Macroeconomics say that the scale is “very lagging”. Unit labor costs are, he said, “the last thing to come back before the recession comes”.

“If you set a policy regarding the cost of the unit of work . . . there’s a 90 percent chance you’ll get it wrong.”