Dissection of European Inflation

A wage-price spiral isn't imminent in Europe, but inflation may take a while to descend.

Inflation readings from the United States have raised hopes that the worst is over and further relief for American households is in the pipeline. For consumers across the Atlantic, however, getting a respite from the high cost of living might take a little longer.

After peaking at 10.6% year over year last October, annual inflation in the 20-member euro currency union decelerated to 7.0% in April. However, a look beneath this encouraging headline figure shows a long journey ahead to bring inflation under better control.

The slump in energy prices has been the primary driver of lower headline inflation readings, as Europe’s natural gas crisis has eased. Core inflation, which strips out energy and food, has steadily ascended to record levels. The super core measure, which consists of items that are sensitive to the business cycle or the output gap, has also risen to a record rate of 6.3% year over year. While there are signs that prices of non-energy industrial goods are falling, services inflation (the single largest component) has reached an all-time high. Inflation is particularly elevated in labor-intensive categories such as hospitality.

Wage growth is increasingly the main driver of underlying inflation in the eurozone amid still-tight labor markets. The contribution of wages to inflation is about twice as large as in 2019-20, a period of stable prices and weak pay gains. Hourly labor costs in the eurozone rose by a record 5.7% in the fourth quarter from a year earlier, exceeding the pace of wage gains in the U.S. The European Central Bank’s (ECB) indicator of negotiated wages has also started to catch up. Recently, German trade union Verdi agreed to a two-year pay deal that would boost the wages for about 2.5 million public sector workers by over 5% in 2023, double the 2.6% increase seen in 2022. In Belgium, many workers received a 10% pay increment.