The average wage growth across the 20 euro area member states slowed sharply in the second quarter of 2024, reinforcing expectations of a potential interest rate cut by the European Central Bank (ECB) in September. Data released by the ECB on Thursday showed that negotiated wages increased by 3.55% compared to the same period last year, down from the 4.74% growth rate recorded in Q1 2024. The slowdown in wage growth was particularly pronounced in Germany, the eurozone’s largest economy, where wage increases decelerated considerably.

Economists at ING highlighted the significance of this wage growth deceleration, noting that it was more substantial than anticipated. In a statement, ING commented, “The decline in eurozone negotiated wages from 4.7% to 3.6% in the second quarter was more than expected. While there could still be upside surprises to wage growth later in the year, today’s wage growth reading makes a September cut by 25bp even more likely.”

Despite sluggish economic activity and improved forecasts, the ECB had previously been hesitant to reduce interest rates while wage growth remained elevated. However, the latest data, showing a drop in wage growth, provides some relief for those advocating a gradual cutting cycle. The 3.6% year-on-year increase in negotiated wages aligns more closely with a medium-term benign inflation outlook, bolstering the case for a rate cut.

ING also noted that while the decline in wage growth is a positive development, it is still higher than what would be ideal for achieving the ECB’s 2% inflation target, given the current weak productivity growth. Forward-looking indicators, however, suggest that wage growth may moderate over time as purchasing power improves and economic activity remains subdued. This, coupled with a potential increase in productivity, could alleviate wage pressures on inflation in the medium term.

Nevertheless, ING cautioned that the path to wage moderation could be uneven. “The second half of 2024 could still bring some upside surprises as unions--most notably in Germany--continue high wage demands at the start of negotiations,” anticipated ING. While such demands could boost consumer spending and slightly improve the economic outlook, they might also complicate the ECB’s policy decisions later in the year.

ING noted that the ECB president Christine Lagarde had previously expressed satisfaction with wage growth expectations and noted that higher wages had been absorbed by profits, reducing inflationary pressures. However, “with today’s numbers showing a drop in wage growth, expectations of a September 25bp cut are growing increasingly firm,” concluded ING.

The monetary policy decision-making team will vote on key euroarea interest rates during the ECB’s meeting scheduled for Thursday 12 September, in Frankfurt.