One fact is now established: in June the European Central Bank will cut rates by 25 basis points for the first time since it began its anti-inflation crackdown, bringing the cost of money to the highest level ever. But the risk, at least for those who were confident in a rapid succession of cuts, is that it could be an isolated reduction, followed by a pause in the next meeting. Caution dominates the agenda in Frankfurt in light of the recent data on rising wages, particularly in some countries (Germany in the lead), which are feared could trigger a resurgence in inflation, after months of a gradual but constant decline. And it was the ECB itself that said it: a rate cut in June is “probable” but we must not rush to reduce the cost of money too quickly, said Isabel Schnabel, member of the Executive Council, in an interview with the German media Tagesschau .De published today on the Central Bank website but carried out in recent days. And that is before the publication of the data on wage growth being negotiated which surprisingly accelerated to 4.7% in the first quarter from 4.5% in the fourth quarter of 2023, while analysts’ expectations were for a decline.
Schnabel reiterated that every decision is made on the day of the meeting and on the basis of available data but underlined that “the path towards price stability is bumpy”. “We see that some elements of inflation are proving to be persistent, particularly domestic inflation and especially services inflation,” he said. “We are monitoring the situation closely and we need to give ourselves time. I would caution against moving too much quickly because there is a risk of reducing interest rates too quickly. And we should absolutely avoid this risk.”
Beyond persistent inflation in the services sector, which is expected to decline in the coming months, wages are therefore the last obstacle to an easing policy. In June “we will proceed with a prudent” rate cut, Vice President Luis De Guindos told an Austrian newspaper. But, after the first reduction, the path is still to be defined and at the moment there are no indications that others will follow. “There is a high degree of uncertainty” and “for the whole of 2024″ we have not made any pre-conceived decisions on the number of rate cuts or their extent. We’ll see how the data evolves.”
The data on negotiated wages reinforces the ECB’s belief in exercising prudence. As the Eurotower explained in its press release, in fact, the growth of salaries subject to renewal has remained high in the euro area and should remain high throughout 2024, in line with the persistence expected in the forecasts of the Eurosystem staff and reflects the multi-year wage adjustment process. However, wage pressures look set to decelerate in 2024. Feedback from companies participating in the March ECB survey indicates that companies expect wage growth to decline from around 5.4% in 2023 to 4.3% in 2024 .
Some countries have contributed more than others to inflating wage trends. This is certainly not the case in Italy where in the last ten years real gross wages have lost 4.5% of purchasing power and the phenomenon of the ‘working poor’ has grown, i.e. people who, despite working, fall into poverty absolute, as revealed by Istat’s annual report. Poverty is linked not only to one’s income but also to the size of the family and the place where one lives. “Income from work – wrote Istat – has seen its ability to protect individuals and families from economic hardship weaken. Between 2014 and 2023 the incidence of absolute individual poverty among employed people went from 4.9% in 2014 to 7.6% in 2023. For workers the increase was faster, going from just under 9% in 2014 to 14.6% in 2023”.
Things went differently in Germany where not only did negotiated wages increase but widespread use was made of one-off payments to compensate for smaller structural wage increases. As the ECB recalls on its blog, “these inflation compensation payments were particularly widespread and important in Germany, as it involved an exemption from income tax of up to 3,000 euros per employee in the period between October 2022 and end 2024. As of March 2024 more than three quarters of all employees covered by collective agreements in Germany had received an average inflation compensation of 2,761 euros”.
“Germany has been the sole driver of wage rigidity, reflecting the lagged effect of recent wage deals that have aligned with rising inflation,” write Pictet economists Frederik Ducrozet and Alan Lemangnen. And that is where the reason for the surprise rise in wages in the Eurozone in the first quarter is to be found, “with an increase of around 6% on an annual basis, including one-off interventions (a little more according to the Bundesbank, but a little less according to the statistics office Destatis)”. The trend in German wages goes well above the European average, therefore, of 4.7%, thanks in particular to the contribution of the public sector: in the first quarter of 2024, employees of the German Länder received a one-off allowance for inflation equal to 1,920 euros. From an economic point of view, the data reflects the delay with which German wages adjusted to the trend in the cost of living, due to union negotiations. From a political point of view, rather, it leads us to reflect on the repercussions that wage increases can have on the decisions of the European Central Bank regarding inflation and on the repercussions on all other countries. Outside Germany, Pictet finds, wage growth has softened faster than expected, despite resilient growth in the services sector and a still tight labor market.
Germany therefore finds itself in a rather ambiguous position. On the one hand, by favoring wage increases, it has influenced a parameter perpetually under observation by the ECB when making monetary policy decisions more than other countries. On the other hand, at least until now, it has always resisted reducing rates even though the inflation trend was constantly decreasing. At least until now because Bundesbank President Joachim Nagel seems to have now resigned himself to the idea of a cut next month: “If the situation remains as it is now and the projections don’t say something completely different – but that’s not what I assume – then the odds increase that we will see the first step on interest rates.” However, “for me it is important that this decision is made in such a way that it is not thought that we can then proceed on autopilot”. However, Nagel expects wage pressure to decline in the medium term in Germany, so the main source of concern that can currently change the ECB’s programs should disappear.
“In the Council we are seated in alphabetical order”, Nagel said again. “On my left is Fabio Panetta”, governor of the Bank of Italy counted among the doves of the ECB. “A good friend of mine to whom I often say that if he and I agree on something it is good for the whole Council. And I promise you that it will still be the case for the Council in June”, he added in response to a press conference on the sidelines of the G7 Finance meeting in Stresa.
