As a surprisingly resilient economy avoided a recession, employment in the euro zone increased more than anticipated to a new record high last quarter, signaling stronger underlying inflation pressures that could keep interest rates high for longer.

Although it was anticipated that the euro zone economy would contract through the winter, falling energy prices, a mild winter, and unexpected economic flexibility limited the harm to a bloc that still has a challenging 2023 ahead of it.

According to a preliminary estimate from January 31, growth in the 19 countries that share the euro at the end of 2022 increased 0.1% quarter over quarter for a 1.9% increase year over year, Eurostat reported on Tuesday.

But the real surprise was employment, which expanded by 0.4% on the quarter, twice as fast as expected in a Reuters poll, pushing the total number of workers to 165 million. Compared to a year earlier, employment growth was 1.5% in the final quarter of 2022.

Quick employment growth highlights just how tight the labour market is and signals a problem for the ECB in its fight to bring inflation back to 2% from double digit territory last autumn.

A recession was expected to boost the jobless rate, cooling the labour market and keeping a lid on wages. But firms, which struggled to rehire workers after the pandemic, appear to be hanging onto staff even through a downturn.

“The resilience of employment growth will aggravate the ECB’s worries about second round effects on inflation and reinforce the push for an extension of the hiking cycle beyond March,” said Ken Wattret, an economist at S&P Global Market Intelligence.

The highest in recent years expected wage growth increased underlying price pressures, especially in services where wages are the highest cost.

Since workers lost a sizable portion of their real incomes last year, some policymakers worry that it may be challenging to temper nominal wage demands once inflation declines, even though such a growth rate still denotes a decline in real earnings given rapid inflation.

“The surprisingly large increase in employment in Q4 last year is the latest illustration of the euro zone’s remarkable resilience in the face of various headwinds,” Wattret added.

While the likelihood of weak overall growth in 2023 remains, the European Commission on Monday increased its growth forecast from 0.3% to 0.9%.

(Adapted from Reuters.com)

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