ECB’s Knot: Confident About Disinflation, but Need to See Wage Developments

29 April 2024

By Isabel Teles – FRANKFURT (Econostream) – European Central Bank Governing Council member Klaas Knot on Monday said that his confidence about the disinflationary process was growing, but that key conditions related to the labour market needed to materialise for the ECB's 2% target to be met.

In an interview with Japanese financial newspaper Nikkei, Knot, who heads De Nederlandsche Bank, said ‘I'm increasingly confident that we are going to converge toward our 2% target over the medium term’, adding that there was ‘a crucial constellation that needs to develop in line with the return to our 2% inflation target.’

‘[A] crucial prerequisite for that [convergence to the target] is that wage growth and, in its slipstream, increases in unit labour cost will gradually come down’, he explained. ‘They will continue to increase at a rate well above 2%. So, real wages will continue to increase but that's logical for this late stage of the inflation cycle. But these real wage increases will have to be absorbed by lower profit margins.’

The decline in wage pressures was good news, he said, but noted that despite going ‘in the right direction’, to be compatible with the inflation target, wage growth, currently at around 5%, needed to come back to around 2.5% over the medium term.

The ECB would be able to start easing in June if wage and inflation numbers were in line with the projections, he said, warning that, ‘we will have to take a cautious approach after June’ to monitor the developments of unit labour costs.

‘If the data on the labour market and inflation come in as projected, showing a further, gradual decline in wage and price pressures, then I think it's realistic to assume that we will begin to take our foot off the brake, so to speak, by making a first rate cut in June’, he said.

Looking forward, new quarterly projections would be important for decision making and policy recalibration, he said.

‘The whole constellation of unit labour cost and unit profit margins will have to develop in line with our timely return to 2% inflation. That still requires quite an ambitious deceleration in unit labour costs’, he said. ‘So, we will have to establish every quarter whether progress is still in line with our projections. As long as that is the case, we can continue to cut rates also after June. But for after June, I would say: no pre-commitment to any specific time path.’

In the context of a general decline in inflation, he said that he ‘wouldn't overestimate the impact’ of higher oil prices, but said that the ECB would act if the impact became permanent.

‘We should be on alert the moment the impact in oil prices is both sufficiently significant but also significantly permanent to be able or to have the potential to trigger second round effects in wages’, he said.