Euro area unemployment remains near record lows and is expected to decline further in the coming years, yet wage growth is projected to slow, a trend the European Central Bank (ECB) says can be explained by rising labour supply, weaker hiring demand and fewer workers switching jobs.

In a blog post published by the ECB, Oscar Arce, director general for economics, and David Sondermann, deputy head of division in economics, supply side, labour and surveillance, argued that the unemployment rate alone no longer captures the true balance of the labour market.

“Focusing on the unemployment rate alone falls short and can be misleading,” the authors wrote, explaining that labour supply and demand now adjust through a wider range of channels than in the past.

They explained that labour market slack remains a crucial factor for monetary policy assessments of wage growth and inflation, as it reflects the balance between the effective supply of workers and companies’ demand for labour.

The unemployment rate has traditionally served as the central indicator in these assessments and in the euro area it has remained close to its historical low, while projections suggest it could fall even further over the next three years.

At the same time, however, wage growth is expected to decelerate, which appears to contradict the traditional Phillips curve relationship, under which lower unemployment usually pushes companies to raise wages to attract workers.

The authors argued that understanding this apparent contradiction requires looking beyond unemployment and examining other adjustments taking place within the labour market.

One key development has been the rapid expansion of the labour force, which has allowed companies to meet hiring needs without triggering significant wage pressures.

Following the recoveries from the Great Financial Crisis and the sovereign debt crisis, employment growth had largely been driven by reductions in unemployment.

However, after the pandemic, the number of unemployed people has changed far less, even as the euro area created around six million additional jobs over the past three years.

During that period, only about 500,000 of those jobs were filled by previously unemployed workers, while more than three million were taken by immigrants moving into the euro area.

Another 2.5 million jobs were filled by previously inactive nationals, meaning people who had not been seeking work.

Of those newly entering the labour market, around 60 per cent were women, reflecting a strong rise in female participation.

Although both female participation and inward migration had already supported employment growth in the past, their role has strengthened markedly in recent years.

Foreign workers accounted for around 53 per cent of employment growth, compared with 29 per cent between 2015 and 2019, while nationals entering the labour force contributed 43 per cent of job creation, compared with 9 per cent in the earlier period.

By contrast, the unemployed had previously been the main source of labour supply, contributing 63 per cent of job filling between 2015 and 2019.

Another significant trend has been the growing participation of older workers.

Since the third quarter of 2022, the participation rate among people aged 55 to 74 has increased by nearly 1.7 percentage points, leaving more than 1.5 million additional older workers active in the labour force compared with previous generations.

The authors said this partly reflects longer life expectancy and later retirement.

However, the broader outlook remains uncertain as demographic trends point to an ageing population.

According to European Commission projections, the euro area labour force could decline by around 11 million people by 2035 unless immigration and higher participation rates continue to offset demographic pressures.

Beyond the unemployed, the labour market also includes additional potential workers.

Nearly seven million people are considered marginally attached to the labour force, meaning they are willing to work but are either unavailable or not actively searching for jobs.

In addition, around five million workers are underemployed, meaning they would prefer to work more hours than they currently do.

If these workers were able to work their desired hours, the increase would be equivalent to around two million additional full-time workers.

Job switching patterns also suggest a cooling labour market.

When companies struggle to recruit new staff, they typically try to attract workers already in employment by offering better pay and conditions.

But recent data from the ECB Consumer Expectations Survey shows job-to-job transitions have slowed in recent quarters, indicating fewer workers are moving between employers.

The blog said this likely reflects both weaker hiring incentives from firms and a growing preference among employees to remain in their current roles.

Structural changes are also shaping these trends. As Europe’s workforce ages, the share of older employees increases, and these workers are generally less likely to switch jobs or renegotiate wages.

Older workers also face lower unemployment rates, averaging around 4.5 per cent, compared with 6 per cent among prime-aged workers and around 14.6 per cent among younger workers.

Annual job transition rates also decline with age, falling from around 6.5 per cent among younger workers to about 2 per cent among older employees.

Lower labour demand from companies has also played a role in moderating wage pressures.

Instead of layoffs during moderate economic slowdowns, firms may simply reduce hiring or avoid replacing retiring employees.

“Firms might hoard labour to temporarily overcome difficult situations,” the authors wrote.

This behaviour has been visible since mid-2022, with companies posting fewer job vacancies without increasing layoffs or raising unemployment.

As a result, fewer vacancies are now available per unemployed worker, signalling weaker competition between companies for staff.

Labour demand adjustments can also take place through working hours rather than hiring.

More than 80 per cent of firms adjust the hours worked by employees to respond to fluctuations in demand.

During the economic recovery between 2013 and 2019, the average hours worked in the euro area increased by around five hours per quarter, equivalent to 2.2 million full-time jobs.

Hours worked fell sharply during the pandemic and remain below pre-pandemic levels, although they have started rising again as labour hoarding declines.

Overall, the authors concluded that analysing labour market conditions requires a broader approach than simply tracking unemployment.

“Assessing labour market slack requires a broader perspective than the unemployment rate alone,” the authors said.

“Labour supply can change due to migration, participation, underutilisation and hours worked, while labour demand may weaken without triggering layoffs,” they added.

According to the two economists, these broader adjustments help explain why wage growth can moderate even when unemployment remains extremely low, indicating that the euro area labour market may be less tight than the headline jobless rate suggests.