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Europe | Monetary Policy & Inflation
Europe | Monetary Policy & Inflation
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Following the cut at their last meeting, ECB speakers have rallied around several distinct themes (see end section for a full breakdown of all speaker comments):
Based on the data, our conclusions are (more analysis below):
On the hawkish side: the shrinking profit margins are only necessitated while demand remains restricted. Unemployment continues to decline in Europe, which should gradually support demand. Meanwhile, upside risks remain from fiscal policy.
On the dovish side: real rates remain high, and if services inflation momentum fades, disinflation can resume. Meanwhile, a hawkish Fed will tighten monetary policy further, which could require the ECB to ease conditions more than otherwise.
Eurozone inflation dynamics are not too dissimilar from UK ones. Both headline and core inflation continue to drop, but services inflation is stubbornly high in H1 2024 (Chart 1). Looking deeper at the momentum in wage-intensive sectors, the comparison to UK inflation is even more obvious (Chart 2).
The upward revision to the core inflation forecast in June reflects growing risks, which may make it difficult for further dovishness ahead.
Negotiated wages overshot expectations in Q1. While some of the more important voices in the ECB have downplayed the importance of this as one-offs and likely to be absorbed by cost margins, the more hawkish members are increasingly voicing their concern. For now, the ECB’s 2024 target for employee compensation seems reasonable (Chart 3).
As in the UK, the sector-level wage growth is important. Evidence suggests that wage growth has been concentrated most in services, but granular industry-level wage data is difficult to come by at the EZ level.
At the national level, there is some mixed data. Pay in the most important wage-intensive sectors (accommodation & catering) is rising at varying levels between France and Germany. In France, YoY wage growth in the sectors has slowed significantly recently, correlating well with inflation in those sectors. It is still running hot versus historic averages but is growing slower than most other services sectors. Meanwhile in Germany, wage growth is far more volatile, running at a far higher YoY rate, and sits at the top end of services wage growth (Chart 4).
Unit profits are a key indicator for the ECB of cost pass-through to consumers. So far, the evidence from both top-down and bottom-up analysis (Charts 5 & 6, respectively) suggest that profit margins are shrinking sharply across Europe.
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