(Bloomberg) -- A key gauge of euro-area wages failed to slow at the start of 2024 — a warning sign to European Central Bank officials counting on a slowdown to maintain the retreat in inflation.

Negotiated pay increased 4.7% from a year ago in the first quarter, the ECB said Thursday. That’s up from 4.5% in the final three months of 2023 and matches a record set in the third quarter of last year. Most economists had anticipated a drop or a stable reading.

Indications of sustained upward pressure emerged on Wednesday as the Bundesbank said pay in Europe’s biggest economy shot up by 6.2% between January and March, boosted by tax-free one-off payments to compensate workers for soaring living costs.

The data arrive just two weeks before the ECB is widely expected to begin lowering interest rates for the first time since a barrage of hikes to contain runaway inflation. While consumer-price gains have slowed significantly, policymakers say a return to the 2% target hinges on the interplay between wages, corporate profits and productivity. 

As the supply shocks of recent years abate, much of the remaining concern centers on service-sector inflation, which is strongly driven by labor costs. In a blog post, ECB economists said that the general trend in pay is toward moderation, citing the central bank’s newly created tool to track developments.

“Negotiated wage growth is expected to remain elevated in 2024, which is in line with the persistence that has been factored into Eurosystem staff forecasts and reflects the multi-year adjustment process for wages,” they wrote. “However, wage pressures look set to decelerate in 2024. ECB wage-tracker data for the first few months of the year, when most agreements take place, indicate that negotiated wage pressures are moderating.”

That sentiment was echoed by Bank of France Governor Francois Villeroy de Galhau, who noted a “German exception” in the first-quarter figures due to one-off payments, with wages decelerating significantly in other countries. 

“We should not over-interpret,” he told a conference in Paris. “we keep confident in the disinflationary process.”

What Bloomberg Economics Says...

“Negotiated wages in the euro area accelerated slightly in the first three months of the year. That’s unlikely to derail the ECB’s first rate reduction in June but will keep policymakers nervous about committing to future cuts.”

—David Powell, economist. Click here for full REACT

Investors pared bets on rate cuts after following stronger-than-anticipated data on private-sector activity in the euro zone, released earlier Thursday. They now see 62 basis points of easing this year — equivalent to two quarter-point cuts and a 50% chance of a third. Three moves were virtually fully priced as recently as last week.

The euro also gave up a small gain, to trade 0.1% higher against the dollar at 1.0836.

READ MORE: Euro-Zone Activity Hits One-Year High as Recovery Gains Pace

One challenge for officials assessing pay trends is that salaries are hammered out in different ways across the 20-nation currency bloc. While Germany’s current numbers are swelled by the implementation of deals struck in the past, growth has already started slowing in some of the region’s other large economies. 

Several officials have sounded confident that, overall, the data are headed in the right direction. Even Bundesbank President Joachim Nagel has said he expects wage growth to “moderate as inflation continues to recede.”

More evidence on workers’ pay will be revealed a day after next month’s decision, when Eurostat publishes compensation per employee — a metric ECB Chief Economist Philip Lane has called the most comprehensive indicator of wage pressures. In March, the central bank forecast that growth in that gauge will average 4.5% this year and slow to 3% in 2026. That’s a level it deems broadly in line with its inflation goal.

Even so, the combination of firmer economic expansion and stronger salary gains means the ECB’s room to reduce rates beyond June is “clearly limited,” according to ING’s global head of macro research Carsten Brzeski. 

“There is an increasing risk of inflation being sticky and rather staying with the 2%-3% range, instead of settling down at around 2%,” he said.

--With assistance from Mark Schroers, Alice Gledhill, William Horobin and James Regan.

(Updates with ECB’s Villeroy starting in seventh paragraph.)

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