ECB research – The profit, wage and productivity triangulation

The ECB's policy setting is faced with critical questions to assess the appropriate level of monetary policy restrictiveness, due to the risk of inflation stickiness. A key relationship in these questions is the triangulation between the wage growth, productivity growth and profits growth. In this piece, we review recent developments in each component. We conclude that there relies significant uncertainties as regards to the ECB staff's assumptions on the labour market in relation to productivity growth returning to the pre-pandemic trend as well as the assumption that companies are to fully absorb the rising wages without adding upward pressure to inflation. In a growing economy and due to the potential change in labour market dynamics post-covid, these uncertainties warrant monitoring. All things equal, we conclude that risks to the triangulation implies the risk for inflation (and in turn rates) is skewed to the upside.  

As recently as last week, Lagarde pointed to the data points mentioned above as key information ahead of the 12 September meeting. The most relevant releases to watch are 14 August (productivity), 22 August (negotiated wages), 6 September (compensation per employee) and 6 September (profits). On top of this, our high frequency profits indicator is set to give early indications through the July earnings season. Current levels (and estimates) points to profits bottoming out in spring 2024.

Wage growth – A story of catch-up

Euro area wages have been growing at a record pace in 2023 and into 2024. The compensation per employee (CpE), which have traditionally been ECB's favourite wage measure, rose in Q1 24 by 5.1% in y/y from 4.9% y/y in Q4 23, where notably a large part has been a compensation due to the catch up of the recent higher inflation episode. This is seen in the increased payments from through one-off schemes, in particular in Germany. We, as well as ECB, have preferred the CpE measure due to its totality of the payment to the employees. That said as the CpE is also impacted by the numbers of hours worked, and as those changed markedly during and after the pandemic, the focus on the negotiated wages has gained prominence. Negotiated wages rose by 4.7% in Q1 24. However, both the negotiated wages and the CpE is only released with a noticeable lag, thus a recent novelty to assess the wage growth has been the invention of a wage growth tracker using real time information from salary listings on the job portal Indeed. This yoy-gauge has now been on a broad decline since late 2022, and now rises at 3.4%, albeit we caution on this measure due to its relatively short history and thus difficult to assess the predictive power (or leads of which) of wage pressure in a post-covid world. ECB also collects a timely (yet not published) data series, including a forward looking aspect, with input from the national central banks. This points to wage growth to fluctuate around 4% mark until year end.

As a result of the higher wage growth and the declining headline inflation, the real wage growth has now turned positive this year, in next to all euro area countries. The euro area real wage growth is now close to historic high levels at 2.3%, as observed around the GFC.

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