News | Question of the Week, WC 4th February
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Q:Will EZ core inflation react to higher wage growth?
A: A recent working paper by the ECB, https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2235~69b97077ff.en.pdf, sets itself the task to answer the question that many investors have been asking themselves since last year, when Mr. Draghi and his colleagues began referring to higher wage growth as a source of inflation pressures: What is the link between labour costs, employee compensation and price inflation in the Eurozone. The findings of the ECB’s study are straightforward. The paper finds “a strong link between labour costs and price inflation,” but also notes the passthrough is largest in the context of demand shocks—demand pull inflation—and that in periods of sustained low inflation the passthrough could be weaker than the empirical average. We have no objections to these findings, but would add one more detail.
Our analysis suggests that the link between core inflation pressures and higher wages differs substantially depending on the components under study. The two next charts try to show this. The first chart shows the link between mainly non-tradable services inflation and wage growth, which appears strong and relatively stable over time. The current data suggest that services inflation will rise further in due course. The second chart, however, shows a dramatically different picture. It shows that wages exhibit only a passing resemblance with the trend in goods inflation, mainly tradables, and that this component even seems to be trending down over time. This is a problem for the ECB given that non-energy goods accounts for 40% of the core CPI. The central bank has many powerful tools, but it is no match to the impact of the global price-setting process in manufactured goods. Even if services inflation continue to increase, which it probably will, the ECB will struggle to push underlying inflation towards its target of “close to, but below” 2%, at least in the next two-to-four quarters.
(click charts to expand)
Claus Vistesen, Chief Eurozone Economist
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Posted: 5th Feb 2019
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