Investment Research General Market Conditions Euro area wage growth should stay subdued, not supporting core inflation significantly Pernille Bomholdt Henneberg Christian Belling Sørensen Chief Analyst Assistant Analyst +45 45 13 20 21/+44 20 7410 8157 chsr@danskebank.dk perni@danskebank.com 5 May 2017 www.danskebank.com/ci Important disclosures and certifications are contained from page 18 of this report.
Much lower real wage growth even if ECB s forecast proves right Implications of continued low wage growth Wage growth in the euro area remains low despite the continued labour market progress. Nevertheless, consumers have recently benefited from very high real wage growth due to the extraordinarily low inflation. ECB s forecast implies low real wage growth Looking ahead, the ECB expects rising nominal wage growth but even if wages pick up in line with the ECB s projection, we expect real wage growth to be much lower than in the past three years, putting downward pressure on private consumption growth. Additionally, the ECB s projection for wage growth is very optimistic. In our view, subdued wage pressure will keep core inflation low, implying there will not be a sustained adjustment in the inflation path, which the ECB requires in order to tighten its monetary policy. Note: All forecasts are from the ECB s macroeconomic projections from March 2017 Source: ECB, Eurostat, Danske Bank Markets 2
Wage growth is important for inflation and private consumption Rising wages very important for core inflation Consumer spending support fading strongly Core inflation bounced in April but this was due primarily to the early Easter in 2016 and we expect a 0.2pp lower print in May, as wage pressure is not picking up (see more in Core inflation surprised on the upside but not the first sign of higher underlying price pressure, 2 May) A private consumption proxy (employment growth + wage growth - inflation) points to weaker growth in private consumption as employment and wage growth are not set to be strong enough to compensate for the rise in inflation (according to ECB s projection) Note: All forecasts are from the ECB s macroeconomic projections from March 2017 Source: ECB, Eurostat, Danske Bank Markets Note: All forecasts are from the ECB s macroeconomic projections from March 2017 Source: ECB, Eurostat, Danske Bank Markets 3
Absolutely key for the ECB to get wage inflation up Higher wages linchpin for rising core inflation As illustrated on the previous page, a turnaround in wage dynamics is the linchpin for higher underlying price pressure. However, a number of factors indicate wage growth will stay subdued in coming years and will not support core inflation significantly. The factors pointing to low wage growth are different measures of labour market slack, including a high share of underemployed and discouraged workers in periphery countries, low inflation expectations, less impact from higher inflation as negotiated wages are already set and formal wage indexation has declined, lower productivity growth and new jobs being created mainly in sectors where productivity growth is low. No wage pressure: ECB again too optimistic Source: ECB, Eurostat, Danske Bank Markets Several factors (see next page) indicate the ECB is again too optimistic in its wage growth projection. This implies modest support to core inflation in coming years and that the ECB is also too optimistic on core inflation in our view. 4
A number of factors indicate wage growth will stay subdued Drivers of wage growth #1: Labour market conditions #2: Inflation expectations #3: Productivity growth Factors pointing to continued low wage growth #1:1: Lower structural unemployment due to the labour market reforms #2:1: Formal wage indexation has declined sharply #3.1: Productivity growth much lower than prior to the financial crisis #1:2: High share of underemployed workers in periphery countries #2:2: Negotiated wages already set in many sectors and countries for 2017 #3.2: Job creation is mainly within low productivity sectors #1:3: Higher share of discouraged workers in periphery countries #2:3: Inflation expectations have come down following the lowflation period #3.3: High share of long-term unemployment results in skill deterioration #1:4: Low participation rate among prime working age males #2:4: Wage pressure is low even in countries with tight labour markets Source: Danske Bank Markets 5
#1: Labour market conditions #1.1: Lower structural unemployment rate due to labour reforms NAIRU in the periphery is likely to be lowered Wages should pick up when NAIRU is reached ECB 2019 Wages: 2.4% Unemp.: 8.4% ECB 2018 Wages: 2.1% Unemp.: 8.9% ECB President Mario Draghi, 27 April 2017 We don t have an estimate of the NAIRU at the moment. We base our estimates on a variety of indicators, so in this sense we avoid the trap of being linked to a precise number that depends on a variety of factors and we use a fairly wide range of indicators to inspire and inform our policy-making. ECB 2017 Wages: 1.8% Unemp.: 9.4% ECB 2016 Wages: 1.3% Unemp.: 10.0% Source: ECB, Eurostat, Danske Bank Markets Source: ECB, European Commission, Eurostat, Danske Bank Markets 6
#1: Labour market conditions #1.2+1.3: Potential additional labour force should keep wages low Labour force (persons aged 15-74) 252.8m Active population 162.0m Inactive population 90.8m Employed 145.7m Unemployed 16.2m Full-time workers 113.4m Part-time workers 32.4m Potential additional labour force ECB President Mario Draghi, 6 April 2017 Labour market slack will lessen as unemployment continues to fall but it is unclear how quickly this will feed through into wage dynamics especially if the experience of other advanced economies is instructive. A strengthening labour market may attract marginally attached workers back into the labour force, or encourage those underemployed to seek more hours, causing the effective supply of labour to rise in tandem with demand. Domestic wage pressures may therefore only materialise later in the economic expansion. 6.9m Underemployed part-time workers 32.7% 76.3 % 1.6m Persons seeking for work but not immediately available Males Males 46.9% Females Females 53.1% 6.6m Persons available for work but not seeking 42.1% 57.9% Source: Eurostat, Danske Bank Markets 7
#1: Labour market conditions #1.2+1.3: Stronger labour market may encourage underemployed to seek more hours and appeal to marginally attached workers Underemployment remains high in periphery Also a high share of discouraged workers During the financial crises, the share of employment within part-time jobs has risen, which could point to labour market slack but a better measure is the share of part-time workers who prefer to work more. In the euro area, this share has gone up, driven by a rise in the periphery countries. The share of persons available to work but not seeking work has also risen in periphery countries, pointing to slack in the labour market Source: Eurostat, Danske Bank Markets Source: Eurostat, Danske Bank Markets 8
#1: Labour market conditions #1.4: A strengthening of the labour market may also result in a higher participation rate among prime working age males Slack among prime working age males Rising activity but due to the older population The participation rate in the euro area did not decline during the financial crisis but this reflects higher participation among females and the older population. Among prime working age males, the participation rate has declined, which also indicates slack in the labour market that needs to be reduced before wage growth picks up. Source: Eurostat, Danske Bank Markets Source: Eurostat, Danske Bank Markets 9
#2: Inflation expectations #2.1: Formal wage indexation has declined but there is still no sign that wages are more responsive to labour market conditions ECB: slower reaction of wages to inflation ECB president Mario Draghi, 6 April 2017: A number of factors might slow down the reaction of wages to higher inflation: 1. Wage negotiations in many countries and sectors have largely been concluded for this year, meaning any impact of higher inflation via negotiated wages is likely to be delayed (see next page). 2. In countries where formal wage indexation has declined sharply during the crisis, the pass-through of headline inflation to wages may have weakened. 3. That pass-through also depends in part on labour market slack, as in an environment of high unemployment trade unions may be prepared to prioritise job security over some loss in real wages. Wages not responsive to labour market Source: Eurostat, Danske Bank Markets 10
#2: Inflation expectations #2.2: German negotiated wages are lower in 2017 than in 2016 German wage agreements, which have been concluded, all have lower wage growth in 2017 Wage agreements, pay rises 2016 2017 2018 % of employees in sector covered by collective bargaining (2014 estimate) # of workers affected Banking 1.50% 0% 1.1% Doctors at municipal hospitals 2.30% 2.00% 0.7% Construction (Western/Eastern Germany) 2.4% / 2.9% 2.2% / 2.4% - Metal industry 2.8%* 2.00% - Chemical 3.00% 2.30% - Printing industry 2.00% 1.80% - Federal and municipal public service 2.40% 2.35% - Cleaning sector 2.6% / 4.2% 2.0% / 3.8% - 77% (Financial and insurance aggregate) 39% (Human health and social work agg.) 40% (Construction) 45% (Manufacturing aggregate) 45% (Manufacturing aggregate) 45% (Manufacturing aggregate) 100% (Public administration) 83% (Education) 45% Administrative and support service activities aggregate 230,000 55,000 800,000 800,000 (3,8 mio expected total) 550,000 19,000 2 mio. 429,000 Minimum wage 0% 4.00% - - 3-4 mio (Estimate) Source: German Federal Statistical Office, Danske Bank Markets In Germany, where the actual unemployment rate is below NAIRU and continues to reach new lows, wage growth has been fairly stable around 2.5% for five years. Looking ahead, despite the strong labour market, it does not seem that the higher inflation has spilled over to higher wage growth, as the current wage agreements all have lower German wage growth in 2017 compared with 2016. 11
#2: Inflation expectations #2.3: Medium-term inflation expectations remain low Inflation expectations at QE announced level Survey-based inflation expectations also low The ECB argues that the risk of deflation has virtually disappeared but following the period of lowflation medium-term inflation expectations are lower judged by both market and survey-based measures. The low inflation expectations could persist unless the ECB allows the economy to run hot, eventually lifting inflation. Source: Bloomberg, ECB, Danske Bank Markets Source: ECB, Danske Bank Markets 12
#2: Inflation expectations #2.4: Wage pressure low in countries with tight labour markets Low wage growth across strong economies Euro area labour market progress is lacking Wage growth Latest* Avg. past 20 years*** US 2.40% 3.00% Sweden 2.30% 3.30% Germany 2.40% 1.50% UK 2.40% 2.80% Euro ex Germany 1.00% 2.10% * 3-month moving average of latest wage growth data ** For UK average is from 2001-2017 Source: Macrobond Financial, Danske Bank Markets Low wage pressure seems to be a global phenomenon, as even countries with the tightest labour markets are not seeing much wage pressure yet. In Sweden, the new industry wage deal in our view shows that true inflation expectations are lower than stated. The deal is for three years with total cost increases of 6.5% as wages will increase by an average of 2% per year and then there is another (total) 0.5% in terms of a so-called flexible pension fund. This wage agreement is important for the entire private sector as for the past several years the Swedish wage model has been based on the idea that industry, which is highly exposed to international competition, must set the benchmark for overall private sector wages. It is not an absolute ceiling but the intention is that other deals shall be close to the mark. One interesting observation from the Swedish press conference with union representatives was that they unanimously stressed that this deal will ensure real wage increases over the coming three years. Asked how that can be, considering the 2% inflation target, the answer was basically that given historical experience, they are quite convinced that real wages will continue to rise. Source: Macrobond Financial, Danske Bank Markets 13
#3: Productivity growth #3.1: Productivity growth is low in an historical perspective Productivity growth lower than prior to crisis Marginal return to more education decreases One of the factors adding to the current low productivity growth is a slowdown in human capital accumulation, as the marginal return to additional education is decreasing. Adding to the factors mentioned above, which weigh on wage growth, is weak productivity growth. Since 2012, productivity growth has been below 0.5% down from 1.0% in the period running up to the financial crisis and 1.5% in the 1990s when it was strongly supported by innovations in information technology. Source: ECB, Danske Bank Markets Source: ECB, Danske Bank Markets 14
#3: Productivity growth #3.2: Jobs are mainly created in low-productivity sectors Employment is rising in the service sector where productivity growth is very low Employment creation has been stronger in low-productivity service sectors than in industry, which puts a drag on average wage growth, as these sectors tend to be associated with lower wage levels and growth rates. Service sector productivity growth has historically been low and close to zero since 2012 Source: Eurostat, Danske Bank Markets Source: ECB, Danske Bank Markets 15
#3: Productivity growth #3.3: Long-term unemployment results in skill deterioration Long-term unemployment is declining but high Long term unemployment high in periphery The higher long-term unemployment rate could put downward pressure on wages, as long-term unemployed risk experiencing skill deterioration, which makes them less favourable to potential employers thereby putting downward pressure on average wages. Source: Eurostat, Danske Bank Markets Source: Eurostat, Danske Bank Markets 16
IMF: Global disinflation in an era of constrained monetary policy Inflation surprises affecting expectations The factors pointing to subdued wage growth and therefore not a significant support to core inflation are to some extent consistent with the components in a New Keynesian Phillips curve. According to estimations done by the IMF, there has been an increase in the sensitivity of inflation expectations to inflation surprises an indicator of the degree of anchoring of inflation expectation in countries where policy rates have approached the zero lower bound (see IMF World Economic Outlook, October 2016). Although the magnitude of this sensitivity change is modest, it suggests the perceived ability of monetary policy to combat persistent disinflation may be diminishing. New Keynesian Phillips Curve Headline inflation #2: Inflation expectations #2: Previous inflation Import + commodity price inflation #1: Unemployment rate s deviation from NAIRU IMF World Economic Outllook, October 2016: Disinflation is broad based across countries, measures and sectors albeit larger for tradable goods than for services. The main drivers of recent disinflation are persistent economic slack and softening commodity prices. Most of the available measures of medium-term inflation expectations have not declined substantially so far. However, the sensitivity of expectations to inflation surprises an indicator of the degree of anchoring of inflation expectations has increased in countries where policy rates have approached their effective lower bounds. While the magnitude of this change in sensitivity is modest, it does suggest that the perceived ability of monetary policy to combat persistent disinflation may be diminishing in these economies. 17
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