With European furlough schemes winding down, what is the labour market outlook from here?

01 October 2021

Giovanni ZanniChief Euro area Economist

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Labour issues in Europe have hit the headlines in recent weeks, with shortages of lorry drivers causing major problems in the UK, huge queues at petrol stations and shops warning that there are only days to “save” Christmas. Against this backdrop and with European furlough schemes winding down, we take a look at the state of play in the European labour market and potential implications for the policy outlook.

The European labour market is improving faster than expected

Employment in Europe was up 0.7% quarter-on-quarter and 1.8% year-on-year in Q2, but the increase in the number of hours worked was much more spectacular: hours worked were up 2.7% quarter-on-quarter and 17% year-on-year (the big discrepancy between employment and hours worked is essentially due to the reintegration of workers previously on furlough schemes). Meanwhile, euro area unemployment continued its descent: it fell to 7.6% in July – nearly a percentage point below its peak in Q3 last year and just 30 basis points above its all-time low of 7.3%.

Employment is rising again (% change year-on-year)

Sources: Eurostat, NatWest Markets

Forward-looking surveys suggest things should continue to improve

Surveys suggest the job market is likely to strengthen further over the coming months: the employment component of the euro area PMI in August was only slightly below the 21-year high it hit the previous month. A similar message came from the European Commission survey, where the employment expectations indicator rose further in August – again, to close to an all-time high. What’s more, order backlogs continue to be accumulated quickly – another reason to expect hiring to go on at a fast pace.

Good intentions: most sectors intend to boost hiring

Sources: European Commission, NatWest Markets

Furlough schemes are being wound down

A further sign that things are normalising is that furlough schemes are being wound down across the continent. This is in response to fewer coronavirus cases and reduced mortality rates thanks to the success of vaccination campaigns. At the peak of the crisis last year, furlough schemes in Germany, France, Italy, and Spain were making payments to around a quarter of all employees in the euro zone. By July, this proportion had fallen to 5%. Similarly, in the UK, just 1.6 million workers were still on furlough at the end of July, down from 9 million – 30% of the workforce – at the height of the pandemic last year.

Furlough schemes in the Euro Area and UK compared

Source: National Statistical Institutes, Eurostat, NWM; Note: Euro area based on an weighted average of EA-4 countries.

Risks to the outlook remain

Despite improving employment conditions, and the fact that the most recent wave of coronavirus infections has had close to zero impact on activity in Europe, another surge in cases and hospitalisations is still a possibility as the winter months approach.

Another cause for concern is that the number of cases is still rising in some regions outside Europe – including some parts of Asia. This has implications for economic activity via supply chain disruptions and could also threaten global growth. Such developments would dent the recovery in employment.

Employment is still below pre-pandemic levels. There are still 2 million fewer people in employment in the euro zone than in early 2020, and 4 million fewer than should be under the hypothesis of trend growth.

There’s still slack in the labour market despite improvements (employed persons in millions)

Sources: National statistics agencies, NatWest Markets

While furlough schemes may be winding down, they’re still in place in much of Europe. But this means that some underemployment is still not being fully captured by official statistics. What’s more, the rising number of vacancies is a sign of friction in some labour markets.

Policy support is set to remain in place

It’s clear that the economic outlook is brightening, and the employment situation is improving. But as we discussed above, we’re still some way off full normalisation in employment, and that goes for economic activity and inflation expectations more generally, too.

Against this backdrop, the European Central Bank (ECB) recognises that it needs to continue to provide support to the euro zone economy. Executive board member of the ECB Isabel Schnabel noted in a speech in September that unemployment in the euro area excluding Germany is still higher than before the financial crisis. She also suggested that, adjusting for the base effects due to the pandemic, inflation remains too low rather than too high, and reiterated that what the bank wants to avoid most of all is a premature tightening of monetary policy.

If inflation remains untamed, rate hikes may be brought forward from our current expectation of late 2024 or early 2025, although this is not something we deem likely. But overall, despite an undeniably improving economic backdrop, our central scenario remains that the ECB will continue with its patient and persistent monetary accommodation.

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