(Bloomberg) — The curious strength of the euro-area labor market is driving the European Central Bank’s push against expectations of impending interest-rate cuts.
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Defying economic textbooks, unemployment just hit a record low amid what’s shaping up to be a first recession since the pandemic. The accompanying jump in pay means officials can’t sound the all-clear on inflation — despite it plummeting to less than 3%.
President Christine Lagarde said last week in Davos that wage growth could have a “serious impact” on the ECB’s plans. Like many of her colleagues, she wants to “see the data” on salaries for 2024 before lowering borrowing costs — a message she’s likely to hammer home when she speaks to reporters following Thursday’s policy decision.
Those numbers will only arrive in the spring, however — beyond when investors reckon the ECB will start easing. And such is the mystery around the jobs market that its resilience may yet extend for even longer, potentially further delaying rate cuts.
“The direction of travel is toward easing of the labor market, but even in the most affected parts – like Germany – it’s astonishing how slowly that is happening,” said Soeren Radde, head of European economic research at asset manager Point72. “It’s plausible that wage growth will normalize. My fear is that it will take even longer than the ECB is forecasting.”
The ECB sees unemployment ticking up this year, with pay gains gradually moderating to 3.3% in 2026 from 5.3% in 2023. Some corners of the economy show signs of a slowdown — like Germany’s beleaguered manufacturing sector. But uncertainty is high.
That means the ECB is set to stand pat at its first two decisions of the year — on Jan. 25 and March 7 — with markets seeing two-in-three odds of the first cut coming in April.
How jobs markets worldwide are holding up so well is the subject of much speculation.
‘Labor hoarding’ — where firms are loathe to trim staff for fear of running into a hiring crunch later on — may be one reason, according to economists at the Bank for International Settlements who reckon growing preferences for shorter working hours could be making things worse.
Others point to sick leave, which is more widespread than before the pandemic.
Further complicating matters is a decline in productivity. That’s contributed to a sharp rise in so-called unit labor costs — which the ECB singled out in December as underpinning elevated domestic price pressures.
“It’s very rare to have such a surge in unit labor costs triggered both by higher wage growth and lower productivity,” Sylvain Broyer, chief EMEA economist at S&P Global. “That’s definitively a puzzle.”
While major pay negotiations in Germany won’t happen until the second half of 2024, recent deals indicate continued upward pressure. The salaries of steel-industry and public-sector employees will rise by more than 5% in 2025, while construction workers want a 21% increase for the lowest-paid majority, according to the IG Bau union.
With the Bundesbank only predicting about 3% negotiated wage growth next year, its president, Joachim Nagel, has described salaries as the “great unknown.” His Austrian counterpart, Robert Holzmann, said recent deals signaled still “quite high” increases.
Portugal’s Mario Centeno, a labor economist by training, has sounded most sanguine on the issue, telling Bloomberg TV last week that he doesn’t see many reasons for concern.
Whatever happens won’t just depend on workers’ demands, but also on how companies respond to higher salaries, according to Broyer.
“They basically have the choice between increasing selling prices to keep profit margins stable, which would be detrimental for the ECB,” he said. “Or they can start rethinking their job openings, which would imply that the labor market might be less resilient than we think.”
To make sense of it all, the ECB relies on a myriad of indicators, including a ‘wage tracker’ based on input from national central banks that provides early clues on where pay is headed. An index by jobs website Indeed has also become popular.
Without a rapid deterioration in those gauges, “it’s very easy for the hawks to maintain their line, which is we need to see official first-quarter wage data, which we won’t have by the April meeting,” Radde said.
Definitive figures from Eurostat will only be available at the end of that month, according to ECB Chief Economist Philip Lane. If that’s what the Governing Council wants to act on, the June policy meeting will be the first possibility.
That’s a fact that even analysts who still expect a fist rate cut in the spring acknowledge.
“We believe in April in our baseline, but we also say it requires the ECB to be a bit brave,” said Felix Huefner, an economist at UBS in Frankfurt. “It will not have all the data in April — especially on wages.”
–With assistance from James Hirai.
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