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Wages pose no „imminent” inflation risk

Rising labor costs pose no „imminent danger” to inflation in the 13 euro nations, according to an internal European Commission report, which presents a more relaxed outlook than that of the region's central bankers.

In the confidential study prepared for today's meeting of euro-area finance ministers in Brussels, the commission says that „inflationary pressures stemming from the labor market remain subdued.” Increases in productivity and the supply of workers will curb labor-cost gains even with unemployment at 7.5%, the lowest since records began in 1993, according to the report, which was obtained by Bloomberg News.
Such conclusions are more tempered than the warnings from European Central Bank officials that they may be forced to raise interest rates if higher wage demands fan inflation. ECB President Jean-Claude Trichet said February 8 that „stronger than currently expected wage developments pose substantial upward risks to price stability.”
ECB Vice President Lucas Papademos last week told Italy's Il Sole 24 Ore newspaper that „the likelihood of overly generous increases in wages” is an „upside risk” to inflation. ECB governing council member Vitor Constancio said February 15 that the outcome of wage negotiations is among the „most immediate risks” to inflation.

The commission said „risks appear fairly balanced” as to whether wages would continue to rise modestly or jump sharply, according to the internal report. While falling unemployment and skill shortages in some sectors may push up wage demands, it said gains in worker efficiency and more flexible labor markets were „setting the path for moderate unit labor-cost growth.”
The euro-area economy grew the most in six years in 2006, and the commission this month raised its forecast for growth this year to 2.4% from 2.1%. Europe's expansion accelerated more than expected in the fourth quarter and the manufacturing industry's growth may have gained steam in February, suggesting the economy is slowing only gradually, a survey of economists shows.
The sustained expansion is already prompting some labor unions to begin pushing for higher wages. IG Metall, Germany's largest union, wants 6.5% more pay for workers at companies including Siemens AG and DaimlerChrysler AG, up from a 5% request in 2006.

Economists at ABN Amro Holding NV last week cited rising wage pressures as a reason why they now expect the ECB's benchmark interest rate to reach 4.5% by the end of the year, compared with 3.5% today and the 4% they previously anticipated. ECB officials led by Trichet have signaled they will raise borrowing costs by a quarter point next month in the seventh increase since late 2005. „Strong vigilance remains of the essence so as to ensure that risks to price stability over the medium term do not materialize,” Trichet said February 8, adding that the ECB governing council „will monitor the upcoming wage negotiations in the euro-area countries very carefully.”
The commission, in the confidential report, found common ground with the ECB on how some governments need to do deregulate labor markets more as a way of boosting hiring and investment. The document noted that while German labor costs had moderated enough to bring down the euro region's average, those in other countries had risen in recent years.
„The challenge here is to further enhance wage flexibility at the country level so as to speed up competitiveness adjustment,” according to the commission report. Trichet, who this week testifies before the European Parliament, said February 8 that „moderate increases in labor costs in some countries have been key factors in increasing employment” and that „more flexible produce and labor markets would give rise to new investment possibilities and innovation.” (Bloomberg)