Why the ECB is watching wage deals, not just prices, before December

What happened

In an interview with Japan's Yomiuri Shimbun, published by the ECB on 7 November, President Christine Lagarde said: "We know that inflation numbers will remain high in the quarters to come. The higher they are, and the longer they remain high, the greater the risk to our medium-term target." Euro-area inflation was 4.0% in October, double the 2% target, while core inflation, which excludes energy and food, held at 2.5%.

But she said the ECB is "not seeing signs of second-round effects beyond what we have incorporated in our projections", and that forward-looking wage indicators show "no evidence of a shift yet". On the next meeting in December she said: "I cannot tell you today that we will for sure do this in December", adding that it would take significant changes for the direction to differ from what she expects. Several policymakers have signalled a quarter-point rise from the current 2.5% deposit rate.

What second-round effects are

An oil shock first raises the prices of fuel and heating: that is the first round. A central bank cannot prevent it, and usually looks through it, because energy prices can fall back as fast as they rose. The second round is what happens next. Firms facing higher energy bills raise the prices of other goods and services. Workers, seeing their pay buy less, ask for bigger raises, and firms pass those on too. At that point inflation is no longer about oil: it has become self-sustaining. Central banks raise rates mainly to stop that from happening.

Why wage deals are the early warning

Wages are the largest cost for most service businesses, which is why services inflation tends to follow pay. In much of Europe, pay is set in multi-year collective agreements, so a deal signed this winter fixes wage growth for two or three years. If those deals start to build in 4% or 5% raises to make up for inflation, the ECB would be facing years of higher costs. That is why Lagarde named "multi-year wage agreements" and "companies' wage expectations" as the indicators she is watching.

Where it sits in the chain

This is the bridge between Link 1, inflation, and Link 2, the central bank. The ECB acts not on today's energy-driven inflation, but on signs that it is spreading.

What to watch

• The ECB's wage tracker and new collective agreements in Germany.
• Services inflation in November's flash estimate.
• The choice of Lagarde's successor: Klaas Knot and Pablo Hernández de Cos are the two candidates.