European Central Bank (ECB) Faces Pressure to Lower Rates as Inflationary Wages Decrease

The European Central Bank (ECB) is running out of arguments to continue without lowering rates. The last one to evaporate is the inflationary pressure on wageswhich is moderating, given the lower publication of vacancies by companies and the decrease in the shortage of qualified labor.

The ECB maintained rates this week, as expected, at 4.5%, the highest level since 2001. The market has been reducing expectations of declines from six to four, and assumes that it will make a move in June. Christine Lagarde herself, president of the Central Bank, pointed to the end of spring because there will be “much more data” to evaluate.

Lagarde did a dialectical juggling act by ensuring that the Governing Council had not yet debated a rate cut, although there were conversations about leave behind the restrictive policy. It has not been clear how the restrictive policy can be left behind without lowering rates.

What is evident is that the central bank has fewer and fewer reasons to maintain the price of money at the current level, and this is how investors have interpreted it. The projection of the Euribor, which had increased with Lagarde’s latest speeches, has retreated again. The market now waits for the year to end below 3%according to the future price.

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This will mean lower prices for many variable rate mortgages. And also for new loans from companies and families. Barring some event that causes a rise in inflation, the central bank will be forced to leave behind the hard or hawkish of the last two years to start a cycle of rate cuts, given the period of disinflation and slowdown in economic activity expected for 2024.

The last obstacle that the pigeons faced (members inclined to a softer monetary policy or dovish), and to which the falcons clung (the hawkish, the hardest) was the labor market. Inflationary pressures through salary increase due to employment growth and the shortage of qualified labor.

In fact, in many surveys of managers, the lack of qualified workers to occupy positions in the new economy related to digitalization, cybersecurity or artificial intelligence is one of their main concerns.

In an FTI survey of managers, 47% indicated that there are difficulties in finding workers, a percentage that rises to 80% in the automotive sector. And where else, in Germany. There is a lack of engineers in Bavaria. While in the annual report of Marsh, Zurich and the World Economic Forum, it is among the concerns most cited by businessmen. Furthermore, a new statistic from the European Commission shows a lower volume of layoffs in companies due to fear of not being able to replace positions.

However, and although it is a latent symptom of the labor market that has not gone away, it is weakening. Lagarde acknowledged this week that “companies are announcing fewer job offersalthough fewer indicate that their production is limited by labor shortages.” The aforementioned shortage of engineers in Bavaria, and other skilled employment positions in European markets, especially in the center and north, is reducing .

Eurostat data points to the same trend. Although there are no statistics for the last six months, already in the third quarter of 2023 there was a decrease in unfilled vacancies. Although it was not yet significant, it broke with previous increases.

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In the European Union as a whole, it was seen a year-on-year decrease of 0.3 percentage points, up to 2.6%. In Spain remains unchanged at 0.9%, but in Germany falls by 0.2 points, to 4.1%, in France also by 0.2 points, to 2.1%, and in markets such as Austria, Luxembourg, closely linked to the financial sector, or Finland, the decreases are close to one percentage point. These data are from the third quarter of 2023, long before Lagarde’s appreciation, which suggests that this dynamic has accelerated.

Lagarde also noted that “there are signs that wage growth is starting to weaken”. Already in the fourth quarter, according to Eurostat data this Friday, unit costs slowed, although they remain at a historically high level, with 5.8% year-on-year, compared to 6.5% previously.

The two issues are connected. There are fewer unfilled vacancies, which means that companies are less forced to raise salaries and for workers, their bargaining capacity is reduced.

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“It is expected that the downward trend in inflation will continue in the coming months. Going forward, it should decline to our target as labor costs moderate and the effects of previous energy shocks, supply bottlenecks and the reopening of the economy after the pandemic fade,” Lagarde said.

With energy costs reducing, and the economy normalizing, the salary variable was pending so that the equation results in it being difficult for the ECB to continue its immobility. It must be taken into account that the central banks lost credibility by saying that inflation was temporary, and now they do not want any risk with inflation, although the threat is that they will go too far.

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In the eurozone, the ECB itself already foresees an economic slowdown for 2024, with a GDP expansion of 0.6%, two tenths less than projected three months ago. In this period, it has cut the projection of general inflation by four tenths, to 2.4%, and expects 2% and 1.9% in the next two years. The underlying is close, with 2.6% expected in 2024, 2.1% in 2025 and 2% in 2026.

This means that the central bank believes that core and general inflation will converge, thus the second round effects are dissipating. That is, inflation that generates inflation, for example through salaries.

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The monetary authority has already confirmed that the pressure due to unfilled vacancies is reducing. Furthermore, “profits are absorbing some of the increase in labor costs, which reduces inflationary effects.”

All this cocktail leads investors to wait four rate cuts between June and December, bringing the reference rate to 3.5%, and the deposit facility rate to 3%. This last interest rate marks the remuneration of banking liquidity and is more connected to the evolution of the Euribor.

The three-month Euribor is still trading above the 12-month Euribor, because the market assumes a downward trend, until falling below 3% in December. This level would compare with the 3.679% in December or the 4.022% in December, causing the downward revision of the monthly fee of many variable rate mortgages.

2024-03-09 19:24:23
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