ECB Predicts Strong Wage Growth in Euro Area

he eurozone labour market remained relatively strong in November, with the unemployment rate remaining at a record low 6.5%, posing a challenge for the ECB as the economy slows, but inflationary pressures persist. 

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Unemployment and Monetary Policy

The ECB has raised interest rates several times in the past year to curb inflation, which is well above the ECB's target of 2%. With low unemployment potentially leading to wage pressures, they may need to continue raising rates to keep inflation under control.

According to a study by the ECB, underlying pay growth since the start of the pandemic has been "relatively moderate" and is currently close to its long-term trend. However, the ECB believes that strong labour markets, with increases in national minimum wages and some catch-up between wages and high inflation rates, will significantly increase wage growth in the near term.

President Christine Lagarde has indicated that another half-point hike may be necessary at the February meeting to avoid a wage-price spiral.

Increasing interest rates can help curb inflation by making it more expensive for businesses to borrow money, decreasing demand for goods and services and, in turn, reducing demand for labour. This can help to keep wages and prices from rising too quickly. If left unchecked, rising prices can become a spiral of wage and price increases, which can be challenging to stop.

Potential Risks for the Labour Market

As the monetary policy gets tighter and the economy slows, this will likely add downward pressure on wage growth in line with the ECB's goal of bringing inflation back to target. 

When economic conditions are uncertain, businesses may hesitate to raise wages as they need to be more confident in sustaining higher costs. This can lead to a slowdown in wage growth, even if labour markets remain strong. 

Additionally, businesses may be more likely to cut costs by reducing wages or freezing pay increases to stay afloat during a downturn. As a result, wage growth may decelerate in the longer term, despite the strong growth in the near term.

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