ECB Insight: Policymakers Struggle to Navigate Muddy Waters of Wage Growth

18 September 2024

By Marta Vilar – MADRID (Econostream) – Euro area wage growth may appear to be receding, based on a couple of important indicators that seem to point to a slowdown, but it would be premature for monetary policymakers to feel relief.

For example, in Q2, hourly wages and salaries increased by 4.5% on the year, versus 5.2% in Q1, according to data published on Monday by Eurostat.

That, however, is misleading, due to the volatility of quarterly figures, which were at 3.2% in Q4.

The apparent slowdown of hourly wages and salaries in Q2 confirms more than anything else that the evolution of this variable is simply too bumpy for monetary authorities to infer much from the developments of one or even two quarters.

Similarly, the growth of negotiated wages slowed to +3.55% on the year in Q2 from +4.74% in Q1, according to data published by the ECB on 22 August.

However, Bundesbank President Joachim Nagel said in a speech on Wednesday that this decline ‘was partly due to a one-off effect in Germany (inflation compensation premiums paid in the previous year, which have now been abolished).’

‘Due to the persistently tight labour market in the euro area, a rapid slowdown in wage dynamics is unlikely’, he added.

Nagel is not alone in wondering whether and when wage growth will cool down. Reacting to the latest slowdown of negotiated wages, one of his Governing Council colleagues, speaking to Econostream, objected that ‘there may have been one indicator coming down, but there are still others out there at high levels, particularly in Germany’.

Productivity was so low - indeed ‘partly negative’ – that firms would have no alternative but to pass on the higher wage costs to their customers, he said.

‘So, we cannot look at any single indicator and come to a conclusion that allows us to adjust our policy stance’, he said.

Indeed, Central Bank of Ireland Governor Gabriel Makhlouf cautioned on Friday in a blog post that wages were expected to remain ‘exceptionally volatile’ for the rest of the year.

Similarly, ECB Chief Economist Philip Lane on Monday also warned against expecting an all-clear on the wage front anytime soon.

‘Negotiated wage growth will remain high and volatile over the remainder of the year, given the significant role of one-off payments in some countries and the staggered nature of wage adjustments’, he said. ‘The forward-looking wage trackers also signal that wage growth will be strong in the near term.’

Wage growth is a major factor in Governing Council decisions, with Lane having indicated already in 2023 that the timing of the first rate cut would depend on greater clarity in this regard.

Although the ECB decided in June that developments permitted the easing process to start, and followed that cut with a second one last week, policymakers remain keenly aware of the potential of wages to derail things.

ECB Vice President Luis de Guindos observed on Monday that ‘services inflation is especially sensitive to wage growth evolution’, with services inflation now the ECB’s ‘main concern’.

Lane, though still cautious, tends to think that catch-up from past inflation is driving wage developments, which is why he anticipates what he on Monday called a ‘significant deceleration’ in 2025, when the catch-up process will supposedly run out of steam.

Fellow Executive Board member Isabel Schnabel fears that wage growth is structurally strong.

‘A protracted imbalance between labour supply and demand could more fundamentally challenge the assumption underlying the Eurosystem staff projections that wage growth merely reflects past price shocks and the resulting catch-up process’, she said in a speech at the end of August

Time will tell who is right. In the meanwhile, markets should not make too much of the vicissitudes of individual variables. Policymakers will in any case prefer to see evidence of a sustained trend of more subdued developments, and monetary easing is likely to proceed gradually and cautiously until then.