Christine Lagarde and her colleagues are faced with a choice – whether to press harder on inflation or to encourage renewed economic activity, salary growth, and employment

By Pablo Davidson

07.24.2024 09:54

Photo: Christine Lagarde: “We are determined to ensure the timely return of inflation to our medium-term target of two percent. We will maintain sufficiently restrictive policy rates for as long as necessary to achieve this goal.” Source: Christine Lagarde’s X (formerly Twitter)

Statements from the leaders of the European Central Bank (ECB) about their intentions to reduce key rates revealed something more significant – the prospects for salary growth and further reduction in unemployment. The news is mixed, in fact. Unemployment seems set to remain at its lowest in 15 years, while salary growth is already slowing. However, the good news is that prices are also slowing down.

The speeches by the ECB President are interesting not only for the prospects of changing key rates. On 18 July, when the ECB did not change rates, its President Christine Lagarde avoided making any definitive statements, leaving room for manoeuvre by referring to upcoming statistical releases on prices, unemployment, and wage dynamics expected in August.

For the ECB, Prices Are More Important than Wages

Overall, the European Central Bank actively uses interest rates to stimulate employment and fight inflation. If inflation is too high, rates are raised; if unemployment rises, rates are lowered. Of course, this is a very simplified picture, but it is close to reality.

When signals are needed, ECB President Christine Lagarde does not hesitate. For example, in March 2024, she warned that the period of high interest rates was coming to an end. And in June, as Lagarde promised, the ECB lowered rates, being genuinely confident that the trajectory of inflation towards slowing would continue even amid rate cuts. As before, the ECB aims for a 2% inflation target next year.

Annual inflation in the eurozone stood at 2.5% in June, compared to 2.6% in May and 5.5% at the end of 2023. In the European Union, inflation in June was 2.6% compared to 2.7% in May.

However, in July, the ECB decided to take a pause, leaving the main refinancing rate at 4.25%, the marginal lending rate at 4.50%, and the deposit rate at 3.75%. This followed a 0.25 percentage point cut in June.

Christine Lagarde and her colleagues are faced with a choice – whether to press harder on inflation or to encourage renewed economic activity, salary growth, and employment. It seems that this time Lagarde preferred to fight inflation, given that the unemployment rate in the EU and the eurozone has been at record lows for over a year. The ECB president and her governing colleagues are not even deterred by the latest ECB survey among European companies predicting a slowdown in wage growth.

This was a fairly extensive survey of 62 companies operating outside the financial sector and having business in various EU countries. The survey was conducted in the second half of June, meaning the respondents had the opportunity to consider the ECB's rate cuts.

"The labour market remains resilient. The unemployment rate remained unchanged at 6.4% in May, staying at its lowest level since the introduction of the euro," said Christine Lagarde, ECB President.

In their responses, they foresaw a slowdown in wage growth. On average, they estimated these rates at plus 5.4% in 2023, but by the end of 2024, they expect only plus 4.3%, and for 2025, their forecast is just plus 3.5%. However, as we can see, in 2024 and 2025, wage growth rates will outpace forecast price growth rates, i.e., inflation, by almost twice. Whereas in 2023, wage and price growth rates were almost identical. How can this happen?

This is the result of trade unions achieving compensation for the lag in wages compared to price increases after the rapid inflation of 2020-2023. Despite the accumulated lag in wage levels compared to price levels, this gap is now gradually narrowing. But trade unions continue to insist on faster wage increases to fully compensate for past inflation losses. Thus, the increases in 2024 and 2025 are driven by previously concluded agreements.

At this point, we must remember that too rapid wage increases lead to accelerated inflation. It is quite likely that Christine Lagarde is considering these processes when she avoids specific promises about lowering ECB rates.

Photo: How has the unemployment rate changed in recent years? It has fallen quite skillfully. Source: Eurostat

Numbers That Bring Some Reassurance. But Only Just

In early July, Eurostat reported that unemployment in the eurozone stood at 6.4% as of May, while the overall EU rate was 6.0%. Here and further, the seasonally adjusted unemployment rates are mentioned.

The lowest unemployment rates among the 27 EU member states can be boasted by the Czech Republic (2.7%), Poland (3.0%), Malta, and Slovenia (both 3.2%).

The highest unemployment rates are in Spain (11.7%), Greece (10.6%), and surprisingly, Sweden (8.4%).

But what about employment in such economic powerhouses as Germany, France, and Italy? The situation varies significantly. In Italy, the unemployment rate in May 2024 remained unchanged compared to April at 6.8%. This is almost a 16-year low, reached in April after a slight decrease compared to March. Market expectations had predicted a slightly higher figure of 6.9%, but this did not materialise.

In France, the unemployment rate was 7.4% in May 2024, prompting the government to reduce incentives to remain on social welfare. Prime Minister Gabriel Attal at the end of May unveiled a plan to cut unemployment benefits in France to promote President Emmanuel Macron's economic reforms and get people back to work. Specifically, they planned to reduce the maximum duration of social benefits from 18 to 15 months and extend the required work period to qualify for benefits. But immediately after the second round of parliamentary elections, the government close to Emmanuel Macron sent trade unions a draft decision that the current rules would remain in effect at least until 30 September.

Germany boasts an unemployment rate of 3.3% as of May. This is almost half the average in the eurozone.

Photo: Different countries have different problems. Source: Eurostat

What about neighbouring countries, both near and far? For example, in the UK, the unemployment rate was 4.4% in May, Turkey 8.5%, the USA 4.1%, and Canada 6.4%. In Ukraine, which is currently defending itself from Russia’s invasion, the unemployment rate was 13.1% in June 2024, according to International Labour Organization methodologies. However, accurately calculating the unemployment rate in Ukraine is extremely difficult due to two factors: a significant proportion of men are in the Armed Forces, and a substantial number of women have came abroad for safety.

If we look at the unemployment situation in the EU and the eurozone in dynamics, we see that in May 2024, the seasonally adjusted unemployment rate in both the eurozone and the EU overall did not change compared to April. However, if this indicator remained unchanged compared to May 2023 in the EU, it slightly decreased in the eurozone – from 6.5% in 2023 to 6.4% in 2024. Simultaneously, Eurostat published data on the actual number of unemployed: in May 2024, there were 13.2 million unemployed in the EU, of which 11.078 million were in the eurozone.

And yet, in absolute numbers, the number of unemployed has increased. From April to May 2024, their number increased by 13,000 in the EU and by 38,000 in the eurozone. Over the year, the number of unemployed in the EU increased by 163,000 and by 3,000 in the eurozone.

The youth unemployment rate, i.e., those under 25, remains particularly high. In May 2024, there were 2.828 million unemployed young people in the EU, of which 2.287 million were in the eurozone. Accordingly, the youth unemployment rate in the EU was 14.4%, and in the eurozone, it was 14.2%. Compared to April, the unemployment rate slightly decreased in the EU – from 14.5% to 14.4%, as already mentioned. And in the eurozone, it did not change compared to April.

Even more interesting is the share of youth among the unemployed – in May, it was 21.42% in the EU and 20.64% in the eurozone. These are truly alarming numbers. They mean that approximately one in five unemployed people is under 25. Considering that a significant proportion of people in this age group are still in education, the picture looks even harsher. Moreover, in absolute terms, the number of unemployed youth increased from May 2023 to May this year by 80,000 in the EU and by 32,000 in the eurozone.

In both the EU and the eurozone, the unemployment rate among women is higher than among men: in May 2024, these figures were 6.3% and 5.8% in the EU, and 6.7% and 6.2% in the eurozone, respectively.

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