European Inflation to fall in 2025 due to sharply lower wage inflation
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Article Type
Insights
Topic
Multi-Asset
Published
January 07, 2025
Read time
5 mins
Authors
Jacob Vijverberg, CFA
Jordy Hermanns, CFA
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We anticipate a significant decline in inflation rates in 2025. In response to the surge in energy prices in 2022, wages started to increase to compensate for the loss in purchasing power. This secondary effect has now subsided, and new ECB data indicates that wage inflation is projected to decrease sharply in 2025. For investors, this suggests that longer-duration assets could perform well.


Since the invasion of Ukraine and the ensuing energy crisis, inflation has been a major concern. As the chart below illustrates, the inflation spike in 2022 was initially driven by energy-related components such as transport and energy bills. Subsequently, food inflation also rose due to higher energy input costs. Currently, inflation is primarily driven by services, which are labor-intensive. Wages have been rising in response to the (energy) inflation spike, to compensate for the eroded employee purchasing power.


Figure 1 Components of Eurozone CPI

Figure 1: Contributions to Eurozone inflation. Source: Bloomberg, Aegon Asset Management. Data as per Dec-2024.


Looking ahead, we expect energy prices to remain stable. Oil markets have ample spare capacity, making a price spike less likely. Gas markets, which are particularly important for Europe, remain tight due to the cessation of Russian supplies. However, increased import capacity, a rise in renewables, and production cuts have resulted in a more balanced market. Additionally, more LNG supply is expected to become operational in the next few years.


Wage growth is a significant factor in services inflation. Recently, wage growth has been exceptionally strong, with negotiated wages increasing by 5.4% in the third quarter of 2024. However, this figure is not indicative of future wage growth. In Europe, most employees are covered by collective bargaining agreements that run for up to three years, providing visibility into future wage growth. The ECB has recently published a tracker that incorporates these wage deals (see graph below). The chart also shows the headline inflation rate and services inflation, highlighting the strong correlation between services inflation and wage inflation.


Figure 2 ECB Wage Tracker and inflation

The ECB Wage Tracker extends to December 2025 and shows a drop from 5.3% in December 2024 to just 1.4% in December 2025. Given the high correlation between services inflation and wage inflation, we expect services inflation to fall significantly in 2025. The figures are uncertain and new wage deals could lead to higher numbers; however, challenging economic conditions make this less likely in our view.

These conditions imply that inflation is likely to fall further. Additionally, the risk of persistently high wage inflation appears to have been mitigated. This should give the ECB sufficient confidence to lower interest rates. Markets have partially priced this in, with expectations for the ECB deposit rate to reach 1.75% by the end of 2025. However, lower rates and lower inflation should also benefit interest rate-sensitive assets like longer-duration sovereign bonds. Any increase in rates in 2025 should be seen as an opportunity to lock in attractive long-term yields.

Disclaimer

Authors

Jacob Vijverberg, CFA
Asset Allocation Lead
Jacob Vijverberg, CFA, is the asset allocation lead for the multi-asset team, responsible for both strategic and tactical asset allocation, and co-portfolio manager of the Aegon Global Diversified Income Fund. He also provides macro-economic analysis to internal and external stakeholders.  
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Jordy Hermanns, CFA
Portfolio Manager
Jordy Hermanns, CFA, is a portfolio manager in the multi-asset group and serves as an investment strategist in the asset allocation team. Jordy is responsible for strategic and tactical asset allocation decisions on the asset allocation team.  
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