Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Why Eurozone Wage Growth Is the ECB's Next Headache
Transcript
- Lucas: So there's a number that's been quietly driving a lot of the European Central Bank's thinking this summer, and it's not inflation or GDP. It's the wage tracker. As of the latest reading, negotiated wages in the eurozone are still growing at over four percent a year. And that's a huge deal when the ECB is trying to nudge inflation back to two. Luna: Four percent? That seems high, especially when headline inflation has cooled off so much. I thought the labor market was starting to soften. Lucas: You'd think so. And in some countries it is. But the aggregate number masks a really interesting split. The strength is coming from services and a few specific sectors, and also from the fact that many multi-year wage agreements were signed back when inflation was much higher. So the paychecks negotiated in 2024 are still rolling out. Luna: Right, so there's a lag effect. The wage growth we're seeing now is partly a hangover from the inflation spike. But four percent is still well above what's consistent with the ECB's target, isn't it? Lucas: Exactly. The ECB has said they want wage growth to settle somewhere around three percent to be compatible with two percent inflation, given productivity trends. So four percent is running hot. And that's why you've seen the Governing Council hesitant to cut rates further, even though the economy is clearly slowing. Luna: But isn't there a risk they wait too long and the economy slips into something worse? I mean, real GDP growth just dropped to one and a half percent annualized. Lucas: That's the tug of war. The ECB is basically trying to balance two risks: keeping policy tight enough to prevent a wage-price spiral, but not so tight that they crush the recovery. And the data this week shows just how tricky that is. Wholesale prices were flat in July, below expectations, which suggests pipeline pressures are easing. But services inflation remains sticky, and that's where wages matter most. Luna: So when they look at the details, it's really about services. Can you give us a concrete example of where that's playing out? Lucas: Sure. Take logistics and warehousing. Those are sectors that expanded massively during the pandemic and now are still short on workers. In Germany, the transport union recently secured a deal with around five and a half percent for the first year. Similar story in parts of healthcare and elderly care, where there's a chronic shortage of staff. Those aren't one-off jumps; they're multi-year agreements that keep pushing the negotiated wage index up. Luna: And that feeds directly into services inflation because labor is such a big cost for those businesses. So the ECB sees four percent wage growth and thinks, okay, services prices are going to stay firm. Lucas: Precisely. And it's not just Germany. Spain has been one of the outperformers in the eurozone, but its wage agreements are also running above three and a half percent. The difference is that Spain is also seeing stronger productivity gains, which partially offsets the cost pressure. But the ECB looks at the aggregate, and that aggregate is still uncomfortable. Luna: So what would have to happen for the ECB to feel comfortable? Do they need to see wage growth below three percent for a few quarters? Lucas: I think they'd want to see a clear trend toward three, not just one good quarter. And they'd also want to see services inflation, which is still around four percent in many countries, start to move down. The problem is that wage negotiations are staggered, so even if new deals come in lower, the average takes a while to reflect that. Luna: That's the lag again. So even if the turning point happened today, we wouldn't see it in the data until maybe next year. Lucas: Right. And that's why the ECB is being so deliberate. They keep saying they're data dependent, but really they're dependent on the wage data specifically. You can see it in their communications. Every press conference, the first question is about wages. Last week, when they held rates steady, the statement had a whole paragraph on domestic price pressures, which is code for wages and services inflation. Luna: It's fascinating that the labor market is still so tight despite the slowdown. I mean, unemployment in the eurozone is near historic lows. Why is that? Lucas: A big part is demographics. The working-age population is shrinking in several big economies, especially Germany. So even with weak growth, businesses are reluctant to let workers go because they know they won't be able to rehire. That's giving workers and unions more bargaining power than in previous recoveries. Luna: So it's a structural shift, not just a cyclical one. That makes the ECB's job even harder because they can't just wait for the economy to cool off. Lucas: Exactly. And there's a real risk of a wage-price spiral if firms pass on those higher labor costs to consumers. You see it in some services sectors already. Restaurant prices, personal services, those are still rising at a clip well above the average inflation rate. Luna: That's a good segue into something I've been curious about. How much of this is actually about worker expectations versus actual bargaining power? Because inflation has come down a lot, so you'd think workers wouldn't demand as much. Lucas: That's a great question. And there's some evidence that expectations are normalizing. But the catch is that workers want to recoup the real wage losses they suffered during the 2021-2022 inflation surge. So even with lower inflation, they're pushing for catch-up. Many multi-year deals were struck when inflation was forecast to stay high, so they include generous back-loaded increases. Luna: So it's not just about the future, it's about making up for the past. That's a powerful force. Lucas: It is. And it's one reason why the ECB's own staff models suggest wage growth will stay above three percent through next year. That's a central scenario, not a pessimistic one. So you can see why they're not in a hurry to cut rates again. Luna: And with the euro trading flat against the dollar, there's no external help from a weaker currency that would boost imports and dampen inflation. Lucas: Right, the exchange rate is basically neutral right now. So the whole adjustment has to come from domestic demand, which means the ECB has to keep the reins tight. It's a delicate dance. Luna: I can see why the markets are starting to push back rate cut expectations. The futures market is pricing in fewer cuts for the rest of the year than they were a few months ago. Lucas: Exactly. And you're seeing that reflected in eurozone equities, actually. The Vanguard FTSE Europe ETF is up about one percent over the past week, but it's not a runaway rally. Investors are cautious because they know the ECB is constrained by this wage dynamic. Luna: So if you're an investor listening, what's the takeaway? Should they be worried about wage-driven inflation sticking around? Lucas: I think it's less about worry and more about understanding which sectors are sensitive. Services companies, especially labor-intensive ones like hospitality and healthcare, are going to feel the most pressure on margins. On the other hand, companies with strong pricing power can pass costs through, and that might actually support their revenue growth. It's a mixed bag. Luna: So the wage data is really the key indicator to watch for the next few quarters. It's almost more important than inflation itself. Lucas: I'd say so. Because inflation is the lagging indicator. Wages are the leading indicator for where services inflation is going. And that's what determines how much longer the ECB needs to hold rates at current levels. Luna: Before we wrap up, I want to circle back to something we touched on earlier. The fact that wage growth is partly about catch-up from past inflation. That's a really important nuance that a lot of headlines miss. Lucas: Absolutely. It's not just the current inflation rate that matters; it's the cumulative loss in purchasing power. And that's why wage growth is staying so stubbornly high. It's a rational response from workers who saw their real incomes fall sharply a couple of years ago. Luna: So as we look ahead to the ECB's next meeting, what's the one thing you'll be watching in the wage data? Lucas: I'll be looking at whether new wage agreements start to come in below four percent, and specifically at the second-half settlements in Germany and Spain. Those are the big ones that will shape the index for next year. And also whether services inflation actually starts to tick down. If we see both, then the ECB might find room to cut by the end of the year. If not, they'll hold steady. Luna: And if you want to keep following this with us, we're here every day. For a handful of listeners who want to make sure that keeps happening, there's buy me a coffee dot com slash fexingo. It's a small thing that keeps this ad-free and independent. No pressure, just if it's useful. Lucas: Yeah, that's a nice way to put it. We really appreciate that the show stays free and open. So, back to the data – one thing I find really interesting is how the wage dynamics are playing out differently across countries. Portugal, for instance, has seen wage growth above five percent in some sectors, which is even steeper than Spain. But their inflation is still low, partly because they've had strong tourism and productivity gains. Luna: So there's no single story across the eurozone. It's a patchwork, which makes the ECB's aggregate policy even trickier. Lucas: Exactly. They have to set one policy for a region where Germany is stagnating and Portugal is booming. That's why they lean on the average, but the average hides a lot. And it's why you hear some policymakers arguing for patience – they want to see that the wage surge is broad-based before they react. Luna: So patience is the word for now. And I guess that means the era of rapid rate cuts is not upon us yet. Lucas: Not this quarter, at least. The bar for a cut is high, and the wage data is part of that bar. So we'll be watching the next few prints with a lot of interest.