In the eurozone, inflation has come down, with prices up 2.6% in July versus a year earlier, well within the central bank’s target range. Yet the main concern of the European Central Bank (ECB) has been the persistence of inflation in services, which was 4.0% in July as it was in February. The problem is that services tend to be labor intensive while wages have been rising strongly in a tight labor market.

Thus, the ECB was likely relieved to learn that wage inflation is receding. Specifically, the ECB reported that, in the second quarter of this year, wages set through negotiations between employers and unions were up 3.55% from a year earlier. This was down from 4.74% in the first quarter. This deceleration likely sets the stage for a decline in service inflation in the months to come. As such, it increases the likelihood that the ECB will continue to cut interest rates, having taken the first step in June.

One possible explanation for the deceleration in wages is that the labor market might be weakening. In June, the unemployment rate increased from the previous month. In addition, a survey taken by the European Union (EU) found a “significant worsening of employment plans” at both manufacturing and service companies. In addition, the flash PMI for the eurozone (more details below) found a slight decline in private sector employment in August. If this persists, then wage inflation will likely recede further. Thus, the stage is set for an easing of monetary policy.

Regarding monetary policy, the ECB released the minutes of its last policy committee meeting in July. The minutes indicate that, in July, members had an “open mind” about further rate cuts. Moreover, they were evidently not concerned that core inflation had accelerated slightly from May to June. The minutes indicate that “the September meeting was widely seen as a good time to reevaluate the level of monetary policy restrictions. That meeting should be approached with an open mind.”

In addition, the members noted signs that the eurozone economy is weakening, thereby reducing inflation risk. Also, they noted that the current level of interest rates is “keeping financial conditions restrictive,” thereby increasing the risk of an economic downturn. As such, it is not surprising that the members were amenable to cutting rates in September. Moreover, the minutes were recorded before the latest data on wages and PMIs. This new data likely reinforces the view that the ECB will resume interest rate cuts in September.