One of the greatest talking points in 2017 was inevitably inflation, and it was this key economic gauge which was the primary driver behind the robust performance witnessed in 2017, across both equity and credit markets, as it crept upwards from stubbornly low levels. However, on a historical and fundamental basis, price pressures in the single currency regions remain anchored at unwarranted levels, even though the Eurozone registered a marked economic recovery, which recovery appears to be gaining more momentum quarter on quarter.

One would expect that with an improving (let’s not get ahead of ourselves, the Eurozone economy is merely recovering subdued levels) economy, unemployment should decline and result in higher consumer prices (increase in inflation) and wages. However, 10-years down the line in the aftermath of the 2007/2008, unemployment has indeed improved considerably, but it has been inflation and, most importantly, wage growth, which have impeded the Eurozone economy from blossoming even further.

Last week we had the first inflation print of 2018, covering the month of December 2017, which indicated that consumer prices increased by 1.4%, a drop from November’s 1.5% mainly brought about by a drop in energy prices. This means that the registered decline in December pushed the inflation print even further away from the ECB’s target of 2.0%.

What’s even more worrying is that core inflation, which excludes energy and food-related price movements, is at a meagre 0.9%. This gives reason to believe that the missing link (with all in all increases in GDP and inflation during 2017) remains the stick wage growth. Keeping in mind that interest rates in the Eurozone remain anchored at low levels and that billions and billions of euros have been pumped into the economy, eyes will now be focused on the next move from the ECB as far as monetary policy and the current QE programme is concerned.

It comes as no surprise that the economic recovery was spurred on by the successful ECB monetary stance, with Q4-17 expected to be yet another bumper quarter. Even more, in the absence of key event/macro/political risks, and improved/healthier balance sheets and credit metrics by European corporates, the key ingredients are in place for the Eurozone economic recovery to gather steam…barring wage growth.

With unemployment on a steady decline, the ECB continues to opine that the sustained fall in unemployment will eventually infiltrate into the economy and translate into higher wages. This in turn will inevitably propel price pressures upwards and aid the ECB in reaching its long term target of 2.0%, the timing and speed of which will condition the size and eventual unwinding of the ECB’s bond-buying stimulus program.

ECB’s Draghi has often raised concerns about spare capacity in the economy. With conditions in the jobs market improving wages should start to pick up, thereby supporting consumer demand and boosting consumer prices. But we’ve already been here before, and many market analysts expected to see some form of improvement in wage growth over the past 6 months, to no avail.

So watch out on wage growth in the Eurozone 2018; it will most probably be the most crucial economic indicator which could alter/dictate market sentiment and direction singlehandedly.

This article was issued by Mark Vella, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.