The European Central Bank must continue to raise interest rates and should speed up the reduction of its balance sheet as rapid wage growth is putting upward pressure on an already high inflation rate, Bundesbank President Joachim Nagel said today.
The ECB has lifted rates at the fastest pace on record over the past year.
But recent turbulence on financial markets in the wake of prominent bank failures has raised doubts about its resolve to tighten policy further.
But Nagel made clear that a pause is not in order as inflation, seen averaging around 6% in Germany, the euro zone's biggest economy, will take too long to come back to the ECB's 2% target.
"Wage developments are likely to prolong the prevailing period of high inflation rates," Nagel said in a lecture in Edinburgh. "In other words: Inflation will become more persistent."
Labour markets are so tight that worker shortages are now an obstacle to production and this gives unions increased bargaining power to raise wages, Nagel warned.
Illustrating this point, German trade unions called for large-scale strikes on Monday, disrupting public transport across the country in an escalation of weeks of rolling strikes that have hampered air, rail and bus service.
Wage growth is already too high to be consistent with the ECB's 2% target and, while a wage-price spiral is not yet underway, second-round impacts from income growth will keep domestic price pressures high.
Firms are hoarding labour out of fear that hiring beyond the current economic dip will be too costly and the supply of labour is already shrinking in much of the 20-nation bloc, so structural tensions will remain, Nagel argued.
"It will be necessary to raise policy rates to sufficiently restrictive levels in order to bring inflation back down to 2% in a timely manner," Nagel said.
"We should likewise keep policy rates sufficiently high for as long as necessary to ensure lasting price stability."
Markets now see the ECB's 3% deposit rate rising to 3.5% sometime over the summer but that is below levels above 4% priced in only weeks ago, prior to the recent bout of market volatility.
Nagel also said that the ECB should accelerate the wind down of its Asset Purchase Programme portfolio.