The most crucial part of Europe's economic recovery right now is crumbling

The most crucial part of the eurozone’s economic cycle right now — wage growth — is crumbling.

Karen Ward, chief European economist at HSBC, said in a note to clients on Monday that while unemployment is falling across the eurozone, the fact that wages are stalling could have a detrimental knock-on effect for Europe’s overall economy.

Here are her key points (emphasis ours):

“At this stage in the economic cycle, wage growth is crucial — both for driving a sustainable private sector recovery and for policymakers to judge when an economy is healing and thus whether to alter the policy stance.

“Through the course of last year, there were signs that falling unemployment in the eurozone was putting some upward pressure on wages. The hope was that as this recovery flourished, this would support consumer spending as the boost from low oil prices faded.

“This, in turn, could have made firms more optimistic about long-term demand and more willing to expand and invest. If such a virtuous cycle took hold in the private sector, the reliance on fiscal and monetary support would diminish. So we’re somewhat disappointed, if not surprised, to see signs that wage growth is in fact rolling over.”

And here is the chart:

Basically, while on the surface it looks like everything is going well in the eurozone — after all, lots of people have jobs — the underlying wage growth is an issue because people are not earning enough to keep up with the price rises of goods.

If people have less disposable income, then there’s less money available to pump back into the economy. If fewer people are spending, businesses will make as much profit and will then not be able to reinvest into the business and allow the economy to expand.

HSBC’s Ward says there are three reasons why wage growth is slowing:

1. “Nominal demand is still subdued and firms don’t have pricing power. Now that energy prices have picked up again, they are pushing back on labour cost growth.”

2. “The fall in the unemployment rate may not reflect the true amount of slack in the labour market.”

3. “We believe that households and corporates are adjusting to a new lower equilibrium rate of inflation.”

In other words, the low unemployment rate is masking the real state of the jobs market. People may have a job but they may be working more hours, for less than in previous years. Companies may be growing but are reluctant to pass on some of the cash to wages, instead opting to be cautious because energy prices are going up again and that could push up costs.

And Ward at HSBC warns that “wage growth is crucial to the recovery” so if this issue is not tackled soon, it could pose a major threat to the health of the eurozone.

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