Global Daily – The Eurozone profit slump

by: Aline Schuiling

Euro Macro: Top-down profit growth collapses – The rise in unit labour costs has jumped higher in the eurozone in Q1, which has resulted in a sharp drop in corporate profitability from a macro-economic, or top-down perspective. To begin with, GDP declined by 3.6% qoq in Q1, which lowered the yoy growth rate to -3.1%, down from 1.0% in 2019Q4. Although the labour market deteriorated as well in Q1, employment fell much more modestly (-0.2% qoq) than GDP, as changes in the labour market tend to follow changes in economic activity with a lag of a couple of quarters in the eurozone. Moreover, due to the unique reasons behind the collapse in economic activity – lockdowns – companies probably hung on to more employees than they would normally do during a sharp economic downturn, while the government subsidized temporary employment schemes also encouraged them to keep employees on the payroll. On a yoy basis, employment growth was still positive in Q1 (0.4%, down from 1.1% in 2019Q4). Due to the combined changes in economic activity and employment, labour productivity growth collapsed in Q1, falling to -3.5% yoy, down from -0.1% in 2019Q4. The final component of unit labour costs, compensation per employee, increased by 0.3% yoy in Q1 (down from 1.6% in 2019Q4). As a result of the drop in economic activity and the more resilient growth in employment and wages per employee, unit labour costs increased by almost 4% yoy in 2021Q1, which is close to the average quarterly rises during the Great Financial Crisis, and around twice as high as the rise during the eurozone crisis. Looking forward, we expect growth in unit labour costs to explode in Q2, as GDP growth is expected to drop to around -15% yoy, while the expected declines in employment and wage growth should be much more modest. Although the gradual reopening of the economy, as from early May onwards should push unit labour costs growth sharply lower again in 2020H2, we think that the drop in corporate profitability during the first half of 2020 will continue to weigh on fixed investment for a number of quarter to come. (Aline Schuiling)