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Coronavirus will cause widespread job losses in Europe. We expect Eurozone unemployment to peak at 10 per cent in the July-September quarter compared with 7.3 per cent before the pandemic. That will depress wage rises temporarily but, over the longer term, the risk is that policymakers overstimulate the economy and stoke inflation.

Unemployment should start falling and labour participation rising towards the year-end, though not to pre-pandemic levels. But while labour market prospects look grim, we see a peak-to-trough fall in Eurozone employment of just 3.7 per cent, compared with 4.3 per cent during the 2008/13 global financial crisis – even though GDP fell much further then.

But the very worst of the economic downturn should be short-lived, with growth returning later this year, mitigating the prospect of mass lay-offs. And the unprecedented government job retention schemes that cover furloughed workers' wages should encourage businesses to retain their employees.

If job losses are fairly contained, the resulting drag on inflation may be under half a percentage point – less than after 2008. So headline inflation could return in 2021 to the level of the past four years.

There may be other differences this time. When European unemployment fell sharply after 2013, wage growth remained subdued and companies – particularly in France, Italy, Spain and the UK – maintained or raised profits. So when wage growth eventually picked up, business could absorb the costs without raising prices.

European labour costs were kept low by high immigration, rising labour participation, the gig economy, public-sector pay restraint, welfare cuts, and an oil price slump that depressed indexed wages.

Now, migration has fallen sharply and COVID-19 may exacerbate labour shortages: seasonal agricultural workers unwilling or unable to travel could push up farm wages and food prices. Gig workers may see increased legal protections while minimum wages escalate. And if welfare cuts and public-sector pay restraint previously pushed people into work, a trend away from austerity now could increase labour costs.

Also, the Eurozone labour participation rate has been boosted by increasing older workers. That trend will eventually level-off: indeed, COVID-19 may discourage older people from working longer.

Further, in countries with indexed wages or collective bargaining, past inflation determines pay rises – which, in turn, drives future inflation. But if oil prices have now bottomed, that will no longer drag down wages by the time the recovery really gets going.

Our medium-term outlook is for job losses and disinflation. But for the longer-term, weak labour supply and a shift away from low-cost employment risks weaker economic growth, squeezed company profits and higher inflation.

A large portion of recent Eurozone and UK GDP growth came from employment expansion. If migration and labour participation gains now stagnate, long-term employment growth could be very weak.

But profits cannot be squeezed forever: recovery may eventually give firms more power to raise prices more quickly this time.

There remains the risk that, given the likely hit to the supply side of the economy and massive stimulus measures by central banks and fiscal authorities, inflation eventually begins to take off as the economy recovers.

First published 6 May 2020.

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