ECB Speeds Up Rate Cuts Amid Cooling Job Market
After years of surprising resilience, cracks have finally appeared in the Eurozone labor market, which could help push the European Central Bank (ECB) to lower interest rates more quickly. Despite record-low unemployment rates following inflation shocks and economic struggles, policymakers have seen signs of a shift in the job market that could help convince them to support another reduction in borrowing costs this week.
Although the ECB lacks a dual mandate similar to the Federal Reserve's goals of price stability and full employment, turmoil in the European job market could still have a significant impact on the ECB's inflation outlook. With large companies such as BASF SE and Thyssenkrupp AG already laying off employees, some officials fear that a sudden deterioration in the situation could further destabilize the region, which is teetering on the brink of recession.
Point72 economist Soeren Radde said, "I think they will cut rates in October and will continue to cut rates—even though some hawks argue that there is no automatic mechanism in an easing cycle. They are on this path, and they need to do this. The real key issue is the labor market."
Until July of this year, ECB President Christine Lagarde was still praising the strength of the European job market, stating that the ECB could "take time to gather new information" when formulating monetary policy. Now, it seems that time has passed.
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Currently, data only shows a mild cooling of the Eurozone economy, rather than a rapid downturn. However, job growth slowed to 0.2% in the second quarter, and the proportion of vacant positions dropped from a peak of 3% to 2.6% during the same period. Surveys such as the monthly survey of purchasing managers by S&P Global also paint an increasingly bleak picture.
Michala Marcussen, Chief Economist at Societe Generale Group, said, "The slowdown in job vacancies and hiring speed is a signal that should be of concern—this was clearly also an important motive for the Federal Reserve to lower rates by 50 basis points."
As a renowned labor economist, Mario Centeno, the Governor of the Bank of Portugal, has seen early signs of a softening Eurozone economy: "Some countries are sending more urgent warning signals than others, but all point to a possible reversal in the labor market."
Even hawkish officials acknowledge the issue. ECB Executive Board member Isabel Schnabel also believes that a decrease in demand for personnel makes it more likely for inflation to continue to fall below the 2% target. Latvian Central Bank Governor Martins Kazaks pointed out the risk of a tipping point, where some companies may begin to lay off previously hoarded employees due to disappointing economic performance; he warned, "This could create a kind of snowball effect."
Manufacturing is a key issue—squeezed by weak external demand and domestic competitive disadvantages. Although this situation has been around for a while, a popular theory is that companies keep employees in case it becomes difficult to recruit them again when needed in the future. Some companies seem to have lost confidence in an economic rebound. Volkswagen is a good example, as the company is considering closing its factories in Germany for the first time. Layoff plans in the automotive industry, including Continental AG, continue to emerge. Meanwhile, indecisive consumers mean that the service sector has not yet turned positive.
Therefore, economists at Goldman Sachs predict that in the next few quarters, the unemployment rate in the Eurozone will rise to 6.7%. They say that if the economy performs poorly, worse outcomes could occur—supporting their rationale for cutting rates at every meeting starting this week until the deposit rate falls from the current 3.5% to 2%.The rationale for supporting the acceleration of loose monetary policies is that a softening job market typically translates into slimmer pay raises, thereby reducing inflation. Recently, Barclays economists wrote: "If the labor market continues to cool down, workers may accept more moderate pay raises in upcoming wage renegotiations in exchange for job security."
The European Central Bank assumes that the 2% inflation target will be consistently achieved in the second half of 2025, based on the slowdown in wage growth; however, it also does not wish for the labor market and wage growth to slow down too much.
The Chief Economist of the European Central Bank, Philip Lane, stated last week that a stronger job market "increases the likelihood of achieving the inflation target, rather than being chronically below the inflation target," and compared to before the COVID-19 pandemic, "wage growth in the coming years will be more in line with the target."
Bank J. Safra Sarasin economist Karsten Junius said: "The labor market in the Eurozone still appears to be quite resilient, but there are also clear signs of weakness. The European Central Bank should also respond to this to ensure that there is no significant rise in unemployment and no real recession. This also implies the initial effect of interest rate cuts."
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