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As we all know, both the US and Europe, including the UK along with the EU, are experiencing high inflation. However, how this impacts employees is very different. Employees constitute the bulk of consumers and therefore drive the economy. The employment culture between these major economies has important implications for how the economy could react to inflation. That, combined with different monetary policies, could be a driving force of currency fluctuations.

Last month, EU CPI rose above the US'. The UK’s CPI pushed above the US’ the month prior. With the Fed acting more aggressively to combat inflation than European central banks, this gap could widen. That could increase the difference in how labor practices and laws affect the economy and currencies.
 

The main differences

Generally, the US has “at will” employment, which is often understood as employees can be fired for any reason. But it also means that employees can be hired for any salary, and salary changes are much more flexible. In Europe, employees typically are hired for fixed contracts, often in the framework of collective negotiation. In the US it’s rare to have inflation adjustment included in the contract, whereas in Europe (particularly in the periphery) it is almost standard practice.

When the cost of living starts rising at an unprecedented rate, the reaction of the labor market is quite different. In the US, employees are more prone to change jobs, looking for better salaries. This has led the BLS to report the highest “churn” rate on record, with as many as 4.6M people changing jobs in a month. Despite this, however, average wages have been declining when adjusted for inflation. Employees who can change jobs are keeping up with inflation, those who cannot are seeing their income erode.
 

Slow and deliberate vs fast and erratic

With employees locked into collective contracts, discontent over lower wages translates instead towards industrial action. In recent months, there has been a spate of warnings or outright strikes. Most recently Lufthansa’s pilots were unable to reach an agreement and might go on strike at any time. SAS had to reschedule over 300K passengers because of strikes. One of the key sticking points of these discussions is the inclusion of the automatic cost of living adjustments to wages.

One of the phenomena most feared by central bankers is a price-wage spiral. That’s when higher prices drive workers to demand higher pay, which increases costs to produce goods, causing higher prices, and workers demanding higher pay. An automatic inflation adjustment in labor contracts makes this price-wage spiral easier to develop and increases the potential for runaway inflation.
 

What does it mean for the future?

The theoretical way to head off a wage-price spiral is to aggressively front-load interest rates, to prevent inflation from rising. However, European central banks have relatively speaking, not done that. The Fed has acted a lot more aggressively. On the one hand, because of fixed contracts and collective bargaining, wages were likely to rise slower in Europe. On the other, those rises are likely to come along with strikes and be much broader than in the US, which increases inflationary pressure in the long term.

Basically, inflation might be further entrenched in Europe than in the US, implying that in the long run, the dollar could outperform the pound and Euro.

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