Global Daily: Eurozone retrenchment pressures + BoE negative rates risk

by: Aline Schuiling , Bill Diviney

Euro Macro: Labour costs shoots higher despite government subsidies – Eurostat has published data on hourly labour costs that were incurred by employers in the eurozone in Q2. In a detailed methodological note it describes how the short-time working arrangements and temporary lay-offs that were introduced by a large number of governments during the Covid-19 crisis have impacted hourly labour costs. In most cases, the payments by the government are recorded as subsidies (or tax allowances) and a subtracted from the labour cost index as being a negative non-wage component of total labour costs. In cases where the government directly compensated the employees without channelling the support through the employer, the corresponding amounts are not recorded in labour cost statistics. Therefore, the rise in total labour costs as published by Eurostat reflects the rise in actual costs that are borne by companies. The data shows that the yoy rise in total hourly labour costs in the business sector has accelerated to 4.1% yoy in Q2, up from 3.3% in Q1. In the final quarter of 2019 before the outbreak of Covid-19 the rise was merely 2.2%. The rise in labour costs may well by inflated by measurement problems (especially in recording working hours) as given the economic shock it is unlikely that pay growth was as strong as suggested by these data. The break-down in main sectors in the business economy shows that the rise wat strongest in the services sector (4.4% yoy in Q2), followed by industry (3.8%) and construction (2.8%). As this rise in labour costs has occurred during a period of weak domestic demand, companies will not be able to pass it on to consumers by raising prices. Indeed, we expect the rise in labour costs to add pressure to corporates and to the retrenchment that is already underway. Given weak demand and rising unemployment, we expect wage growth to slow sharply going forward. This should be an extra headwind to both consumer demand and inflation. (Aline Schuiling)

BoE View: Negative rates added to the toolkit, but a rate cut is not imminent – The Bank of England kept monetary policy on hold today, as was widely expected. The most notable new information from the minutes was the reference to negative rates. The MPC had already discussed the potential effectiveness of negative rates in the August Monetary Policy Report, and since then the discussion has moved to how they might be implemented in practice. While the MPC seems keen to add negative rates to its toolkit, however, such a move does not look imminent. The minutes state that “The Bank of England and the Prudential Regulation Authority will begin structured engagement on the operational considerations in 2020 Q4,” and moreover that such a policy would only be deployed “should the outlook for inflation and output warrant it at some point during this period of low equilibrium rates.” We think the MPC is taking this step to ensure it is operationally ready to implement a rate cut if one or both of two risks materialise – 1) a second wave of the pandemic requiring widespread renewed lockdowns; 2) if the UK government fails to secure a trade deal with the EU before the end of the transition period on 31 December.

As if to underline that negative rates are not imminent, the MPC sounded more sanguine about the economic outlook. It noted that the recovery had so far been swifter than expected in the August MPR, and that payments data suggested consumption “is now at around its start-of-year level in aggregate.” The minutes added that “Spending less on one category of consumption did not necessarily mean a reduction in the total […] consistent with the flexibility consumers had exhibited in the types of goods and services that they had purchased during the pandemic.” The MPC continued to sound cautious about the outlook, however, with the minutes noting the 700k rise in unemployment since the onset of the pandemic (which occurred despite the government’s wage subsidy furlough scheme), and the considerable uncertainty related to both the pandemic and Brexit.

A QE boost is likely in December – Given uncertainty facing the economy, and further projected rises in unemployment, we do expect the MPC to increase its asset purchases target at the 17 December meeting, most likely by a further GBP100bn. The minutes confirmed that the MPC continues to expect its current GBP745bn asset purchases target to be reached “around the turn of the year,” and noted that the pace of purchases was now slower “than during the earlier period of market dysfunction.” Similar to the Fed until recently, the goal of asset purchases has been to support smooth market functioning. However, we expect the goal of purchases to turn to supporting the recovery when the next boost to QE is announced. (Bill Diviney)