The European Central Bank, while assessing the sharp short-term inflation triggered by the US-Iran conflict, has indicated that eurozone wage growth is projected to accelerate into early 2027, though it will remain significantly below the previous peak levels.
The ECB's wage tracker, released on Wednesday, forecasts that overall eurozone wages will increase by 2.7% year-on-year in the first quarter of next year, following a 2.6% rise in both the third and fourth quarters of this year. This pace is higher than the baseline wage forecast from six months earlier but remains well below the 5.2% peak recorded in 2024.
As illustrated, the ECB anticipates that wage growth in the eurozone will pick up towards 2027. In a statement, the ECB explained: "The rise in wage growth over the year reflects the fading mechanical drag from large one-off payments, which were made in 2024 but are absent in 2025." It added: "Forward-looking wage and labour market information continues to suggest that negotiated wage pressures will remain stable through 2026 and into the first quarter of 2027."
ECB policymakers are monitoring wage developments with exceptional scrutiny, aiming to prevent energy price increases from triggering a self-reinforcing loop of wages and prices, similar to the energy crisis and record cost-of-living pressures seen after Russia's invasion of Ukraine in 2022.
ECB policymakers held borrowing costs steady at their meeting last week, following a 25-basis-point rate hike in June. However, sources indicate that policymakers are prepared to raise rates again in September unless there is a significant improvement in the inflation outlook.
ECB President Christine Lagarde emphasised that recent indicators confirm the expected "gradual decline in wages," adding: "For now, none of these factors show signs of second-round effects." Yet, some policymakers remain concerned. Officials on the ECB's Governing Council, including Slovakia's central bank chief Peter Kazimir, have warned that the ECB cannot simply wait for such effects to materialise, as acting then might be too late.
The ECB kept its deposit facility rate at 2.25% on July 23, following the 25-basis-point hike in June. Lagarde stated that the full inflationary impact of the energy shock has not yet been felt and that decisions will continue to be made meeting-by-meeting based on data. While the decision to hold rates was unanimous, some members discussed the possibility of an immediate rate hike during the meeting, highlighting a clear tightening bias among certain officials.
The implications of the latest wage tracker are that wage pressures remain sticky but have not yet formed a wage-price spiral. The ECB expects negotiated wage growth to hold steady at around 2.6% in the third and fourth quarters of 2026, before edging up to 2.7% in the first quarter of 2027, far below the 5.2% peak of 2024. This increase is primarily a mechanical effect of one-off compensation payments from 2024 dropping out of the year-on-year comparison, rather than a re-acceleration of underlying wages. Lagarde, therefore, reiterated that no significant second-round effects have been observed. This data reduces the need for aggressive consecutive rate hikes but does not deter the ECB from taking out an additional "insurance" policy against energy-driven inflation.
Officials are broadly divided into three camps. Kazimir is the most hawkish, arguing that at least one more rate hike is needed. He stated that unless there is "very convincing" economic and geopolitical improvement in the coming weeks, he will support a September hike. His logic is that the ECB cannot wait for second-round effects in wages and inflation to fully materialise before acting. Bundesbank President Joachim Nagel, along with some central bank chiefs from Austria and Slovenia, are more hawkish but conditional. They emphasise the high risks of energy and inflation and that the ECB must be ready to respond, but they have not directly committed to a September move.
ECB Chief Economist Philip Lane and President Lagarde are more cautious. Lane characterises the current situation as a "medium-sized inflation shock," predicting that inflation could return to around 2% within a year, and advocates a gradual response based on whether the shock spreads to wages, services prices, and inflation expectations.
Market pricing is broadly hawkish but fluctuates with oil prices and US-Iran developments. Following the ECB meeting on July 23, money markets briefly assigned a roughly 95% probability to a 25-basis-point rate hike in September and a similar probability for another hike before year-end. However, by July 27, interest rate futures pricing had shifted to fully price in another rate increase by the October monetary policy meeting, with any subsequent moves fully priced in by March 2027. This pricing suggests that September remains the most significant risk window, but it is no longer a certainty. The current curve is more consistent with a path where the deposit rate rises from 2.25% to around 2.50%, before potentially increasing further to about 2.75% by early 2027.
Meanwhile, a recent Reuters poll found that approximately 70% of economists expect at least one rate hike in 2026, with the majority pencilling in September. However, the economists' overall expectations are more moderate than the "more than two hikes" implied by swap markets.
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