With vaccines improving the economic outlook and labour market data surprising to the upside, we have revised down our unemployment forecasts for almost all major economies. But wider measures of labour market slack imply a growing divergence by region. While hidden spare capacity should keep wage growth subdued in Europe, there is evidence of labour market tightness in the US and Australia which could cause pay pressures to intensify. Pay growth will do little to boost inflation rates in most EMs.
- With vaccines improving the economic outlook and labour market data surprising to the upside, we have revised down our unemployment forecasts for almost all major economies. But wider measures of labour market slack imply a growing divergence by region. While hidden spare capacity should keep wage growth subdued in Europe, there is evidence of labour market tightness in the US and Australia which could cause pay pressures to intensify. Pay growth will do little to boost inflation rates in most EMs.
- On the face of it, labour markets where governments deployed job retention schemes have been incredibly resilient during the pandemic. In the euro-zone, the UK, and Japan, unemployment rates are only between 0.9%-pts and 1.2%-pts higher than they were in December 2019. (See Chart 1.) In contrast, the US unemployment rate shot up to a record high of 14.8% in April 2020. But while the increase in unemployment was far sharper than during the financial crisis, the rate has also dropped back much more quickly. By January, the US unemployment rate had fallen to 6.3%.
- The news of successful vaccines has brightened the economic outlook, and, in many cases, incoming labour market data have been more positive than we had assumed. Accordingly, we have revised down our unemployment forecasts in most major DMs. (See Chart 2.) The largest downward revisions have occurred in Europe as job retention schemes were extended until at least the start of Q2 – we now expect unemployment rates to peak at 8.8% and 6.5% in the euro-zone and the UK respectively, compared to around 12% and 8% previously.
- But headline unemployment data have not told the full story about the underlying health of labour markets this past year. (See here.) In the euro-zone, the UK, and Japan firms are continuing to report that they are finding it easier to fill positions than before the onset of the pandemic, suggesting that there is more slack in labour markets than implied by official unemployment rates. (See Chart 3.)
- The nature of the pandemic, including the need to shield and/or take time off work due to school closures, means that many people have temporarily left the workforce because they are not able to start work straight away. And the number of people not actively looking for work but wanting a job has risen. So even in the hard data, there is evidence that there is slack beyond the unemployment rate. On our estimates, broad measures of the unemployment rate which account for these people had reached 8% in the UK and 16% in the euro-zone in Q3 2020. (See Chart 4.)
- In contrast, in the US, measures of labour market slack suggest that the official unemployment rate is overstating weakness there. In the US, firms are reporting that it is harder to fill new positions. (See Chart 3 again.) Indeed, the net share of small firms struggling to fill job vacancies is consistent with an unemployment rate of between 3% and 4%. (See Chart 5.) And the voluntary quits rate has now returned to its pre-pandemic level, implying that workers are as confident about their job prospects as they were prior to the onset of the pandemic when the unemployment rate was just 3.6%. (See Chart 6.) And there is a similar story in Australia – the share of firms reporting staff shortages is nearly as high as it was in 2019, which again suggests that the labour market is tighter than the headline unemployment rate suggests.
- As a result, wage pressures will most likely be strongest in the US and Australia this year and next. In Europe, wage growth looks set to rise in the short term as most furloughed workers move back into fully paid employment, exacerbated by the fact that any rise in unemployment will be concentrated among the low-paid. But once this has passed, excess capacity should see wage growth drop to 2% and below in 2022.
- Meanwhile, wage growth in emerging economies should, for the most part, remain subdued. The limited available data suggest that unemployment rates surged during the early stages of the pandemic. And a lack of fiscal support in economies including India has meant a greater risk of worker displacement and long-term labour market scarring which will limit pay pressure. There are two key exceptions. In China, the strength of the economic recovery has meant that employment is already back to pre-pandemic levels. This should cause pay pressures to intensify somewhat, which is one reason we expect core inflation to edge up this year. Meanwhile in emerging Europe, labour markets were already tight ahead of the pandemic. While unemployment rates rose, we expect them to drop back quickly causing wage pressures to strengthen.
Chart 1: Unemployment Rates (%)
Chart 2: 2021 Average Unempl’t Rate Forecasts (%)
Chart 3: Measures of How Easily Firms Can Fill Positions (Std. Dev. From Long-Run Average, 3m Av.)
Chart 4: CE Broad Unemployment Rate (%)
Chart 5: US NFIB Jobs Hard-to-Fill Index
Chart 6: US Voluntary Quits Rate
Sources: Refinitiv, Capital Economics
Gabriella Dickens, Global Economist, email@example.com