Euro zone wage concerns keep ECB cautious on rate cuts

ROBUST early-year wage growth for euro-area workers will do little to calm the nerves of European Central Bank officials pondering how much they can lower interest rates.

Data from the bloc’s largest economies suggest increases in negotiated pay failed to slow significantly in the first quarter. The danger is that companies pass rising costs on to consumers, keeping inflation above 2 percent for longer.

A key culprit is Germany, where past deals—some of which are embellished by one-off payments— have driven salaries sharply higher. Policymakers are unlikely to be sufficiently consoled by evidence of moderation elsewhere in the region.

So while June’s planned initial reduction in the deposit rate is almost sure to proceed, any hopes for another quick-fire move the following month are receding. Underpinning the case for caution is stronger-than-expected economic expansion in the 20-nation bloc— even as inflation backpedals toward the target.

“For the ECB, strong German wage growth will be another reason to move very carefully with rate cuts—even if wage growth in most other euro-zone countries is much more muted,” said Carsten Brzeski, an economist at ING.

Pay gains probably slowed to 4.3 percent from a year ago in the first three months, compared with 4.5 percent for the final quarter of 2023, according to Bloomberg Economics. While not surpassing 3.5 percent in France, Italy and Spain, they reached 4.8 percent in Germany, it said.

“National data on negotiated wages have been trickling in over recent weeks and they point to a nearly steady rate of increase in pay settlements. That’s unlikely to derail the ECB’S first rate reduction in June but will keep policymakers nervous about committing to future cuts,” said David Powell, Bloomberg’s senior euro-area economist.

For the ECB, part of the challenge is that negotiations work very differently across the continent. Whereas many contracts in Belgium are directly tied to inflation, German and Italian workers must often await new rounds of talks that determine compensation over multiple years.

In France, meanwhile, bargaining is more flexible and salaries in a host of sectors are agreed on once a year, Barclays economists said last week in a note.

Such complexities are reflected in the array of views on the first quarter. While ING’S Brzeski sees acceleration to roughly 5 percent, Nomura analysts expect steady growth of 4.5 percent and the estimate over at Barclays is for a slowdown to about 4percent.

“There are some indicators from the labor market that suggest wage growth in the euro area is decelerating,” said Barclays economist Christian Keller. “This should contribute to further disinflation, which is already more pronounced than in the US.”

Those less optimistic point to a tight labor market that shrugged off a shallow recession in the latter half of 2023. Germany witnessed a string of transport strikes this year, and some construction workers seeking better pay are set to walk out this week for the first time in 17 years.

“The undersupply of labor will put upward pressure on wages,” Berenberg chief economist Holger Schmieding said. “We therefore don’t project nominal wage growth to settle below 4 percent on a sustained basis.”

Official data on negotiated wages are penciled in for May 23, with another closely-watched gauge of first-quarter pay growth to come from Eurostat on June 7—a day after the ECB next decides on rates.

With timely information scarce, officials in Frankfurt have sought to provide more clarity through their own, newly developed trackers of euro-area pay.

Those “continued to show signs of easing,” according to an account of April’s policy meeting, published Friday. Rate-setters have also stressed that corporate profits should absorb some of the higher labor costs after margins expanded in recent years.

To what extent this happens in the services sector—a primary focus at the moment—is uncertain, the ECB’S policy account showed.

“While progress had been seen, monitoring the triangle between wages, productivity growth and profits continued to be key,” it said.