EUR under pressure: Wages cool, interest rate cut in the horizon

A Key Eurozone Wage Growth Indicator Plummets, Supporting ECB Rate Cut Outlook

A key measure of wage growth in the eurozone has sharply declined, reinforcing the European Central Bank’s (ECB) claim that inflation is on track to hit its 2% target and backing calls for further interest rate cuts.
Contractual wages rose by 2.4% year-on-year in the first quarter, the ECB reported on Friday. This is down from 4.1% in the last three months of 2024 and less than half the peak of 5.4% recorded last year.

The data strengthens the view that wage pressures are easing and will eventually lead to weaker core inflation, which has so far remained resilient. Prices in the services sector, where wages play a key role, rose by 4% in April.

“We’re seeing that contracts signed this year feature quite low agreed increases, and even lower ones for next year,” ECB Chief Economist Philip Lane said Friday. “So we are confident that services inflation will come down.”

ECB officials are also optimistic that overall inflation, which stood at 2.2% last month, will reach their target in the coming months. The European Commission forecasts inflation will fall to 2% by mid-2025 and remain below that level in 2026, partly due to U.S. tariffs and their impact on financial markets.

The Governing Council is widely expected to cut rates for the eighth time this cycle at its next meeting in June. Traders are pricing in at least one more cut by year-end — a forecast officials like Belgium’s Pierre Wunsch call “reasonable.”

“The sharp slowdown in contractual wage growth suggests the ECB may soon declare victory in its fight against inflation. This would allow the Governing Council to focus on the economic impact of U.S. tariffs and ease monetary policy again in June, and possibly once more later this year.”

After years of strong wage hikes, recent agreements show workers are finding it increasingly difficult to secure desired terms. Public sector unions in Germany recently agreed to a 5.8% increase spread over two years, calling it a “hard-won result.”

An ECB indicator designed to forecast future wage increases also signals a sharp slowdown by year-end. The central bank is set to release new economic forecasts on June 5.

Analysts at Morgan Stanley warn that wage indicators will remain volatile for now, partly due to widespread one-off payments in Germany. They forecast stronger contractual wage growth in the current quarter, before another slowdown in the second half of the year.

Expectations for the euro, in light of recent economic data and ECB communications, point to short-term depreciation. The slowdown in wage growth and clear signals from the ECB that inflation is steadily moving toward the 2% target lay the groundwork for a rate cut in June. This would make the euro less attractive to investors, especially compared to currencies backed by higher interest rates, like the U.S. dollar.

Markets are now expecting at least one, and possibly two, key interest rate cuts by year-end. If the ECB acts more aggressively than anticipated, pressure on the euro could intensify. At the same time, trade tensions with the U.S. and potential new tariffs pose additional risks for the eurozone economy, which could further weigh on the common currency.

Ultimately, if the current direction of monetary policy holds and economic data continues to support a scenario of slowing inflation and growth, the euro is likely to remain under pressure. A decline against the dollar and other higher-yielding currencies seems a logical continuation of current trends.