Banque nationale de Belgique : Why does the ECB keep a close eye on wage developments

The ECB left rates unchanged in April 2024, stressing that "domestic price pressures are strong and are keeping services price inflation high". Future rate decisions will depend on an assessment of wage and price dynamics and the strength of monetary policy transmission, further to an assessment of the inflation outlook based on incoming economic and financial data. The present article investigates the mutual dependency between wages and (core) inflation and the implied challenges for monetary policy decision-making. The developments in Belgium are compared to euro area averages.

The wage catch-up process has been rapid in Belgium, but more gradual in the euro area. Wages caught up quickly in Belgium, due to the country's system of automatic wage indexation based on consumer prices. In the euro area, however, the adjustment process, which is based on periodic negotiations, takes longer. As a result, in early 2023, real wages in Belgium (i.e. those adjusted for inflation) had returned to their 2020 year-end levels, which was not yet the case in the euro area at the end of 2023. In some euro area countries, the impact of wage negotiations on pay will only be visible in the course of 2024 or later, especially as there is not always a clear timetable for negotiations.

Productivity growth has been limited. For firms, the effective cost of wage increases can be mitigated by an increase in output per employee (labour productivity). Over the last five years (2019-2023), however, productivity growth in Belgium has been far from sufficient to offset fully the large wage cost increases faced by companies (especially in 2023). This raised so-called real "unit labour costs". In the euro area, the average fall in real wages did help to push down real unit labour costs. This occurred despite productivity losses caused, in particular, by "labour hoarding" (the retaining of employees, even during lulls in activity, due to a tight labour market).

The risk of a wage-price spiral has been contained. Domestic inflation has been tempered as cost pressures have been partially offset by companies' lower profit margins. This also happened earlier in Belgium (2022) than in the euro area (2023). Alongside this, a number of forward-looking indicators, such as the new ECB "wage-tracker", which monitors recent wage agreements, do not point to the risk of a wage-price spiral. Moreover, long-term inflation expectations derived from surveys of economic actors remain anchored to the inflation target (2%), while short-term expectations have fallen sharply. This suggests that the ECB deployed a credible and effective response to the inflationary shock by raising its key interest rates.