The ECB's house of cards
After the expected interest rate pause in July, the European Central Bank appears to be heading for a rate cut in September, and more easing measures during 2025. However, much of the central bank's optimism regarding the inflation outlook is based on the fact that the ECB expects wage growth to slow in the coming quarters. This will reduce the stubbornly high service inflation, which is significantly influenced by labour costs. However, like a house of cards, this forecast could collapse very quickly. Should this happen, the financial markets will have to prepare for a much more restrictive monetary policy than they currently anticipate – especially for 2025.
According to several ECB surveys, companies do indeed expect wages to rise less in the coming months. In addition, a weaker-than-expected euro area economy could reduce the scope for further price increases due to higher labour costs. There is also some evidence to suggest that wage growth will weaken noticeably – and ultimately, inflation with it.
Employees' bargaining power is increasing
The sharp fall in inflation over the past twelve months will not necessarily lead to more moderate wage demands from employees and trade unions. Not only because many employees still have some catching up to do in view of the loss of purchasing power since 2022. The arduous search for employees for many companies – not only for skilled workers but also for unskilled labour – increases the power of trade unions in collective bargaining. Under these circumstances, sustained high wage growth is anything but an absurd notion.
In the coming months, the financial markets should, therefore, focus less on the new inflation data, and more on the upcoming wage data. On 22 August, the data on newly negotiated wages in the second quarter will be published – there was an increase here at the start of the year. New data on labour costs and profit margins is due on 6 September. Labour costs have also risen recently, as has the wage index from the job platform Indeed.
Wage growth is likely to fall, Lagarde reiterated after the last interest rate decision. However, if this turns out to be wishful thinking, financial market participants will have to brace themselves for persistently high key interest rates.
