. this implies additional uncertainty around the baseline for both growth and inflation. some of this uncertainty will recede as the fallout from recent events in financial markets becomes clearer. but faced with overlapping shocks and shifting geopolitics, the level of uncertainty will most likely remain high. to confirm the outlook in our projections over time, we therefore also need to look at additional indicators that can be observed in real time. underlying inflation to that end, the second input we will be drawing on is the dynamics of underlying inflation. underlying inflation is not a policy target, but measures of underlying inflation can serve as a complementary cross - check of our forecasting process. underlying inflation is typically quite inertial and therefore gives us an indication about the persistence of inflation into the medium term. we will be looking to see a sustained downward turn in underlying inflation measures to be confident that the inflation path will converge to our target in the medium term. so far, we do not see clear evidence that underlying inflation is trending downwards. in fact, we see two forces pushing underlying inflation in different directions. to the one side, falling energy prices are weakening a key driver of underlying inflation pressures. imported energy prices have played a central role in pushing up inflation for all economic sectors, given the huge energy shock we have faced. this is why measures of underlying inflation that capture the more persistent effects of energy costs are already showing a decline. to the other side, increasing domestic price pressures could offset some of this disinflationary impulse. measures of underlying inflation that capture items sensitive to the business cycle – such as supercore – or items with low import content are still strengthening. if this continues and aggregate demand picks up from its current compressed levels, we could see a handover from imported to domestic price pressures that keeps overall price pressures high. the key issue in determining which of these forces wins out will be developments in wages. the euro area has suffered a large terms - of - trade loss owing to rising energy prices, the cost of which must ultimately be shared between firms and workers. and it is important that there is fair burden sharing between them, with both accepting that they cannot fully recover the income that the euro area has paid to the rest of the world and the ensuing loss of output. so far, real wages have decreased substantially, while firms ’ profit margins have expanded in many sectors. but the labour market is quite tight, labour shortages are increasing, and the terms - of - trade shock has largely reversed.

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. at the same time, the unemployment rate is at a historical low and, in some countries, it is so low that it will be increasingly difficult to recruit from the remaining pool of labour. all this means that we could see a more prolonged cost - push shock coming from wage growth. this is unlikely to prevent goods disinflation, since wages represent only around 20 % of direct input costs for manufacturing firms. but wages make up around 40 % of direct input costs for services providers, and services inflation accounts for almost two - thirds of core inflation. in parallel, firms ’ profit margins continue to grow, in part because some are taking advantage of supplydemand imbalances to test consumer demand with large price increases – over and above their increase in costs. but in the absence of a persistent rise in market power [ 8 ], this can only continue insofar as demand remains resilient. otherwise, firms will have to absorb cost increases in margins and price pressures will start to ease. this