Although wages have contributed little to inflation in recent years, European Central Bank (ECB) President Christine Lagarde warned against cutting interest rates too early as wages could push inflation up again later this year .
“Wages are expected to become an increasingly important driver of inflation,” she said during a monetary policy dialogue with the European Parliament on Thursday (February 15) in Brussels.
Inflation in the EU is expected to fall from a strong 6.3 percent last year to 2.7 percent this year and be only slightly above the bank's baseline target of 2.2 percent in 2025.
In an economic “winter forecast” also published on Thursday, the European Commission lowered EU growth forecasts for 2024 to 0.8 percent from 1.2 percent in the autumn forecast, as high interest rates weigh on economic activity.
“The recovery expected in 2024 is likely to be more modest than forecast three months ago,” said EU Economic Commissioner Paolo Gentiloni.
When presenting the “autumn forecast” last year, Gentiloni had already indicated that interest rates would have placed a “greater burden on the eurozone economy than previously expected”.
Partly due to the deteriorating economic outlook, interest rate watchers are betting that the ECB will start cutting interest rates this year, possibly as early as April or most likely in June, from the current record high of 4 percent.
But Lagarde refused to commit to a date on Thursday.
“We don’t have enough evidence yet that we will reach our 2 percent target and stay there,” she said, adding: “The last thing I want is for us to make a hasty decision and then inflation see it rise again.” “
The focus on the potential wage inflation risk is striking because the ECB's own research suggests that inflation in the euro zone is largely driven by energy and food supply disruptions and has little to do with demand or wages.
Around 80 percent of the ECB's errors in inflation forecasts had to do with energy prices, Lagarde said on Thursday.
Interest rate risk
Meanwhile, keeping interest rates high is not without risks.
At the end of January, the Federal Statistical Office reported that the country's economy shrank by 0.3 percent in 2023, which was due, among other things, to the fact that high interest rates dampened investments.
Furthermore, according to the ECB's latest Financial Stability Report, published late last year, homebuyers' loan defaults and late payments are increasing due to higher mortgage costs, and some banks are showing “early signs of stress.”
However, this is offset in the meantime as the ECB pays banks higher interest rates on their deposits than commercial banks pay their customers.
Last year this led to a cash transfer to commercial banks worth 146 billion euros.
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