We did this when we decided to use reinvestments under the pandemic emergency purchase programme more flexibly, and when we agreed on the transmission protection instrument. These programmes ensured that rate normalisation proceeded smoothly. The third element of a robust strategy is a clear reaction function. At our last meeting, we clarified our reaction function and the sources of information that will be important to us. The future calibration of the rate path will be determined by – and will require continuous monitoring of – three key inputs, and this is what I will explain now. The inflation outlook The first input is our assessment of the inflation outlook in light of the incoming economic and financial data. This will be informed primarily by our staff inflation projections. Monetary policy must be forward-looking, given the lags with which our policy works. And the staff inflation projections are the best mechanism for distilling incoming economic and financial data into a comprehensive picture of medium-term inflation dynamics. The future rate path will depend on whether we see inflation converging durably to our target in our forecasts, and the level of confidence we have in this convergence as captured by the balance of risks. Our latest forecasts see headline inflation at 2.1% in 2025 and core inflation at 2.2%, which is a downward revision compared with our last projection round in December. But the confidence band around these forecasts is now unusually wide.
This is leading workers to use their bargaining power to recoup lost income. For the seven countries covered by the ECB’s wage tracker,[4] collective bargaining during 2022 led to an aggregate wage rise of 4.7% for this year. This is already playing a stronger role in core inflation. While wage-sensitive items[5] contributed only around 0.5 percentage points to core inflation before the pandemic, that contribution has more than doubled in recent months. If both workers and firms accept fair burden sharing, and stronger wage growth represents merely a rebalancing between labour and capital, then both wage and price pressures should diminish as this process plays out. But if both parties attempt to unilaterally minimise their losses, we could see a feedback mechanism between higher profit margins, wages and prices. The risk of such a “tit-for-tat” dynamic is also heightened by the prospect that labour market tightness will linger. Unlike other jurisdictions, labour participation in the euro area has grown robustly since last year[6], helping to address part of the soaring labour demand driven by reopening. But the pandemic has also led to a sharp increase in public employment[7], reducing the pool of labour available to the private sector. And how much further labour supply can expand overall will depend, among other things, on complex policy questions such as countries’ attitudes to immigration and childcare.