Europe's Contented Workers Could Be Worsening Draghi's Deflation Woe

Wage growth in the currency bloc isn't fast enough to bring price gains back in line

Low inflation, Mario Draghi once famously said, means people can “buy more stuff.”

The consumption-driven recovery in the euro area is currently proving the ECB president's point. But can the consumer be in too good a mood?

If price gains are so slow that employees stop seeing the need to demand higher wages, then that makes Draghi's task of returning euro-area inflation back to the target of just under two percent all the more difficult. Euro-area annual inflation came in at 0.1 percent in October.

Wage settlements in the region rose an annualized 1.56 percent in the third quarter, just above the record-low of 1.44 percent at the beginning of the year, ECB data released Tuesday show. While the bloc's unemployment rate of just under 11 percent is clearly weighing on salaries, even in areas where joblessness is low, like Germany, there are few signs of wage inflation.

“Workers adjust their demand to the low inflation pattern,” said Alexander Koch, an economist at Raiffeisen Schweiz in Zurich. “The current environment doesn’t push workers to request higher wages.”

To be sure, wage dynamics are notoriously asymmetric; especially in Europe they don’t contract in response to a downturn as much as they rise during a boom. And while they are near a record low, that's still way above inflation.

But soft wage settlements today can crystallize weak inflation for years to come. That's one of the reasons why the ECB will consider fresh stimulus at their Dec. 3 policy meeting.

“Salaries are probably the main driver of services inflation,” said Marco Valli, an economist at UniCredit SpA in Milan. “This low level of wages growth confirms a picture of only slow pick up in core inflation.”

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