Mixed signals

Last Updated on Thursday, 13 July, 2023 at 12:33 pm by Andre Camilleri

Silvan Mifsud is director of Advisory at EMCS Tax & Advisory. Mr Mifsud is also a council member of The Malta Chamber

The results from various local and international economic indicators, give very mixed signals, which many times are difficult to reconcile.

From the local front, we know that in Q1 2023 Malta’s GDP grew by just over 3% when compared to Q1 2022. We also know that the labour market remains tight, with many employers finding it hard to fill vacant positions. On the other hand the latest economic update issued by the Central Bank indicates that in May, sentiment in the retail sector fell below its long-term average, with this latest decline in confidence largely reflecting a sharp deterioration in retailers’ expectations of business activity over the next three months and their assessment of sales in recent months. Moreover, confidence in the manufacturing industry also turned negative in May standing at -11.4, down from 8.5 a month earlier, with this sentiment falling below the long-term average, as production expectations for the months ahead decreased strongly from the very high level recorded in April. On the other hand, the sentiment indicator for the services sector stood at 37.8, below the 44.2 recorded in the previous month, but still well above its long-term average, with this latest decrease driven by firms’ expectations of demand over the next three months. Finally, the consumer confidence indicator decreased to -9.9 in May from -6.9 in April with expectations of major purchases turning negative in May and the consumers’ expectations of the general economic situation over the next 12 months turning more negative.

From an international perspective, the same mixed signal is making the job of economic policymakers a nightmare. The ECB is becoming increasingly concerned about an apparent disconnect between a seemingly buoyant jobs market and mounting signs of economic stagnation. On one hand the ECB is seeing that unemployment in the Eurozone is at a record low and companies are struggling to fill vacancies, but on the other hand, the eurozone economy is suffering a mild contraction over the past two quarters. A further analysis of the figures indicate that this disconnect between the strength of the jobs market and the weakness of economic growth lies in a fall in workers’ productivity, which is contributing to an overall Eurozone 5.5% inflation rate, which is far too high. Why is this so? In essence it seems that across the eurozone, people are working fewer hours, with a higher proportion of full-time employees working fewer hours on average. This could reflect a growing preference for leisure time after the dislocation of the Covid pandemic led people to rethink their priorities.  On the other hand the ECB suspects it has more to do with labour hoarding, where companies hang on to workers even as business tails off because they are worried they will be unable to hire again easily when the economy picks up. Whatever the case, the end results is that companies are taking on more staff just to keep output constant. This could in turn mean interest rates need to rise and stay high for longer, to keep wage pressures in check. Christine Lagarde, the ECB president, has warned that unless companies are willing to “absorb” the cost of the drop in productivity, monetary policy will have to become even more restrictive.

However, a tighter and more restrictive monetary policy also comes with its fair share of risks. An analysis of the jobs growth in the eurozone shows that the strongest jobs growth was in the less productive sectors, with a lot of the job creation happening in the public sector, where working hours tend to be shorter, and in services, where productivity tends to be lower than in industry. This was especially so in Germany and Spain, where a surge in hiring in health and education has offset sluggish private sector demand. It is clear therefore, that if there is a permanent shift to public from private sector jobs, across the eurozone, then that would imply productivity would be lower in the longer run. This means that while an increase in interest rates would be intended to slow down private sector employment, if this were already sluggish, the end result would be that the increase in interest rates by the ECB would be needlessly destroying private sector jobs and slowing down the bloc’s economies even further.

This is a very tricky period. The fact that we are in an inflationary period, just after a pandemic and a war in Europe, makes the situation trickier. We are facing inflation that has been triggered by these unique events, on the basis of one of the longest periods of expansive monetary policies in history. Finding a path out of this is proving to be very difficult and more complicated than central bankers thought it would be a year ago.

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