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Member of the Executive Board of the European Central Bank Isabel Schnabel He said the slowdown in euro zone inflation was welcome. He predicted that inflation would slow to around 2% by the end of next year, in line with the ECB’s own forecast.
At the same time, Schnabel noted that the current headline inflation rate underestimates the monetary policy challenges that remain. For example, he cited price pressures within the eurozone, known as domestic inflation.
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“Domestic inflation is particularly stubbornly high, at 4.4 percent, reflecting in large part persistent price pressures in the services sector, where the slowdown in inflation all but came to a halt in November,” Schnabel said in a speech on Friday.
The services sector and wage developments are particularly important in domestic inflation. The ECB has long warned about the impact of rising wages on inflation.
Wage risks also threaten Finland
Isabel Schnabel said that although recent statistics showed that overall wage growth slowed in the second quarter from April to June, wage risks remain. The president of the German central bank warned that unit labor cost growth may remain high for longer than expected and forecast.
“Increases in unit labor costs are likely to disappoint amid strong wage growth. Although wages are rising at a slower pace according to the survey, escalating wage negotiations suggest that the recovery of workers’ purchasing power may take longer than expected,” Schnabel said.
He also reminds us that, although in some countries, such as Portugal and Spain, the average real wages of employees have returned to pre-pandemic levels, the negative situation is particularly prominent in a few eurozone countries. Finland is one of these risk countries.
“In Italy, Germany and Finland, a significant proportion of employees still have real wages significantly below pre-pandemic levels.”
Schnabel cautions that if labor market conditions remain tight, wages could rise even more strongly. Here, the imbalance between labor supply and demand is essential. This is a problem, especially in Finland.
“Although demand for labor is slowing, it remains high in an environment where unemployment is at historically low levels and a large number of companies, especially in the service sector, still view labor as a limiting factor in business development. If labor shortages prevent companies from increasing output, then increased demand will lead to higher inflation rather than higher output.”
Another reason why unit labor cost growth may remain higher than expected is the weak recovery in productivity growth.
“If part of the current weakness is not cyclical but more persistent, the recovery in productivity growth could be weaker, reflecting structural challenges. Indeed, the recovery in productivity growth has repeatedly been slower than expected over the past year,” the central banker said.
Schnabel, who is involved in the preparation of the ECB’s executive board’s interest rate decisions, refrained from taking a direct position on changes to the key rate during the autumn.
“Together with the risk of a weakening economy, the risk that a dovish and gradually more restrained monetary policy will derail the return to price stability is now smaller,” he commented with satisfaction.
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