Central banks face a dilemma. Substantial monetary tightening has reduced headline inflation, but core measures are proving sticky, both in Europe and the United States. Even though inflation is still well above central bank targets, markets expect policy rates to be near their peaks. As central banks retain credibility, most measures of inflation expectations remain anchored.
The risks of inflation reaccelerating appear limited, especially as we expect central banks to maintain a restrictive monetary stance for an extended period. Past experience with advanced economies indicates that wage-price spirals do not materialise when monetary policy remains focused on meeting the inflation target. We also expect wage growth to moderate as growth slows and labour market pressures gradually ease, as currently underway in the United States. In the Eurozone – where wage growth picked up later than in the United States and with significant dispersion across countries – it may take longer for wages to moderate, but here, too, the weakening economic environment should contain any significant rise in real wages. Our reading of market-based expectations is consistent with this.
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