Eurozone productivity barely improved in the second quarter and again did not meet the expectations of the European Central Bank, which is a major blow to its efforts to bring inflation back to 2%.
Labour productivity per capita fell by 0.4%, according to new data published by the ECB. This follows a decline of 0.5% in the first three months of 2024. and compares with a drop of just 0.3% forecast in the ECB staff projections in June.
While a more productive workforce is essential for economic growth, it is also a key plank in the ECB’s stance to bring inflation back to its target level. This is based on a combination of moderating wage growth, the absorption of part of wage increases by corporate profits, and increased productivity to reduce the cost per unit of output.
Some officials, including President Christine Lagarde, have highlighted the importance of the “nexus between profits, wages and productivity.” If adequate improvement does not materialize, Sustained interest rate cuts may prove difficult.
Some analysts say the ECB’s view that productivity will rise by around 1% in 2025 and 2026, faster than the 0.6% it averaged over the two decades before the pandemic, is too optimistic, even after a downward revision to the June forecast.
The new data may contribute to this growing skepticism and fuel the debate about further reductions in borrowing costs.
“With a further decline in productivity, the risk of inflation remaining high for longer clearly increases”said Carsten Brzeski, head of macroeconomic research at ING.
For the next monetary policy meeting in September, “there is a new problem for the ECB that is slowly but surely simmering under the surface: How to sell a rate cut when your inflation forecasts are again revised up,” said Brzeski.
In June, officials announced a widely publicized reduction in borrowing costs. and at the same time raised inflation projections for 2024 and 2025, sparking a debate over whether the move was justified.
“More broadly, with these productivity figures the argument for a rate cut It would have to be weak eurozone growth rather than easing inflation,” said Brzeski.
Piet Haines Christiansen, an economist at Danske Bank, called the new data “worrying.”
“The first key publication of the ECB triangulationshows that productivity growth in the second quarter is worse than what staff projected in June”he said. “If wage growth does not slow sufficiently, the ECB might not receive enough reassuring news to announce another rate cut and therefore keep the rate on hold in September.”
Markets are fully pricing in two more rate cuts this year and see an 80% chance of a third, despite a surprise rebound in eurozone inflation in July to 2.6%.
Wages continued to rise at a high pace at the start of the year as workers struggle to offset the impact of inflation. The ECB will publish data on negotiated wages for the second quarter on 22 August.
