Wage growth slows, giving ECB room to cut rates in September | Financial Markets

One of the biggest concerns that emerged from the European Central Bank’s latest meeting was the rapid and relentless pace of wage increases. Will the labour market enter one of those vicious circles of rising wages and prices that are so hard to stop? The answer to that question is now closer to negative: wages in the eurozone rose by 3.55% in the second quarter, compared with 4.74% in the first three months, suggesting that the pressure on inflation from labour incomes may continue to ease. The ECB is thus now removing one of the biggest obstacles that separates it from the lever of interest rate cuts.

These favourable figures were already known on the day the minutes of the ECB’s last meeting, held on 18 July, were published. They looked at the issue with some trepidation: “concerns were expressed that wages could continue to rise faster than would be consistent with the inflation target.” And yet, continued inflation in the services sector is mentioned as a “central element” in determining the pace of inflation.

The July meeting was fairly peaceful, if you look at it from the perspective of the usual tug-of-war between hawks and doves: the minutes recall that the decision to leave interest rates unchanged was taken unanimously, putting aside, at least temporarily, the divergence between interest rates and the previous meeting, when Bank of Austria Governor Robert Holzmann – one of the most hawkish of all, who will leave his post next September – openly opposed a rate cut, with some members expressing their doubts about it.

The truce may be short-lived, however. Three weeks from now, on September 12, there will be another litmus test of the Government Council’s unity. That day, the price of money is scheduled to fall by 25 basis points, and decisions to cut or raise rates tend to polarize their supporters and opponents more than those who support maintaining the rate. status quo.

In July, ECB President Christine Lagarde took pains to make clear at her press conference that a September rate cut was not guaranteed. Anything could happen, no matter how long markets ignored the cut. “This cautious approach was particularly justified given the prevailing uncertainty about the development of wages, profits, productivity and service inflation,” the minutes said.

The idea of ​​taking a break, skipping August and waiting until September seemed like the perfect solution at the time, and was well received by everyone. “The September meeting was generally seen as a good time to reassess the level of monetary tightening,” the text says. The immobility of the Federal Reserve, which, unlike the ECB, had not yet cut rates, reduced the pressure to act, and its members agreed to come to the September meeting “with an open mind.” Carsten Brzeski, head of macro at ING, drew a compelling conclusion from the discussions at the last meeting. “It is clear from today’s minutes that the ECB would like to continue cutting rates and is more confident about what to do than it was at the June meeting,” he sums up.

Concerns about the economic slowdown appear to be gaining momentum compared to the level of concern expressed by the Government Council. “Members acknowledged that the short-term growth outlook had deteriorated. This was evident in both the firm and uncertain data, particularly the weak manufacturing PMI,” they acknowledged.

Tourism could be a countervailing force to support the economy, but the ECB does not think its efforts will be enough in the second half of the year. And there was some swearing in the discussion, albeit without the drama of the past. “It was argued that the short-term outlook had become somewhat more “stagflationary”points to the text. ING’s Brzeski believes that the reference introduces into the debate the eternal dilemma of whether central banks should continue to fight inflation or act to save the economy, but he believes that this will not be decisive in the short term. “The new stagflation risk is not yet large enough to prevent the ECB from cutting rates again in September.”

It is unclear to the Governing Council whether this deterioration in activity will be temporary or more long-term, and a fresh rate cut was hinted at. “It was stressed that a gradual easing of restrictive policy is a balancing act, as it is also important not to cause undue harm to the economy by keeping rates at a restrictive level for too long.” The positive side of this weaker economic data is related to inflation: the ECB found that it helps contain the risks of rising prices.

Disinflationary currency market

The minutes tell us what happened a month ago, but the statistical machine did not stop for the holidays. They brought with them some additional setbacks, such as July inflation, which rose by a tenth to 2.6%, or the persistent inflation in the services sector, which fell only from 4.1% to 4% in the same month, but which seems to be a new argument for cutting spending. Especially after the positive data on the slowdown in wage growth in the eurozone, which was largely driven by Germany, where contractual wages rose from 6.2% in the first quarter to double in the second.

There is also good news on the foreign exchange market, but with its own nuances. The euro’s rise against the dollar continues and is already close to 2022 levels. This trend is deflationary, since Europe pays for gas and oil in dollars, so the rise of the single currency means that it pays what is cheaper for energy imports. However, an overly expensive euro also poses a threat to economic growth, since it makes exports less attractive and makes Europe more expensive as a tourist destination.

The market is expecting two more rate cuts this year, one mentioned in September and another in December, which, in addition to the one in June, will bring the price of money to 3.75%. All eyes have been on the central bankers’ symposium starting this Thursday in Jackson Hole, Wyoming, where Philip Lane, the ECB’s chief economist, will speak on Saturday.

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