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Wages in the Eurozone’s largest economy are rising at their fastest rate this century, fuelling disquiet among some economists about next month’s expected interest rate cut from the European Central Bank.
Negotiated wages in Germany are expected to shoot up by 5.6 per cent in 2024, based on deals agreed between January and June, according to data published on Tuesday by WSI, a trade union think-tank. The pay increase, in real terms, will be the fastest since their records began in 2000.
Although the rises are far in excess of rate-setters’ overall 2 per cent inflation goal, policymakers in Frankfurt have baked “elevated” pay growth into their forecasts.
The ECB’s calm in the face of higher pay pressure comes from a belief that workers are still “catching up” after their purchasing power was eroded by inflation. Even with this year’s 5.6 per cent pay rise factored in, only half of German workers’ losses between 2021 and 2023 have been compensated.
ECB president Christine Lagarde in June cited a 12 per cent wage deal for public sector workers in Germany — the first in three years — as an example.
“You can imagine that an agreement that is cut in 2024 and that covers [lost purchasing power in] 2021, 2022 and 2023 is obviously going to be very sizeable,” she said.
Markets are pricing in a more than 90 per cent chance of another 25 basis point cut in September, following June’s reduction in the deposit rate from 4 per cent to 3.75 per cent.
Policymakers’ confidence is shored up by the reversal of a phenomenon dubbed “greedflation”, which means it is harder for companies to pass on extra payroll costs to their customers.
Rate-setters believe businesses used the combination of high input costs and strong consumer demand to raise prices and boost profit margins in the immediate aftermath of the pandemic. Now, with growth stagnant, profit margins look set to shrink. Unemployment, meanwhile, remains low, meaning workers can push for wage increases.
However, not all rate-setters are convinced that the ECB will manage to avoid what Lagarde has referred to as “tit-for-tat inflation”.
Robert Holzmann, the hawkish Austrian central bank governor who was the sole member of the rate-setting governing council to not support a cut in June, said the rise in Eurozone labour costs would weigh on the region’s competitiveness.
“The potential loss of competitiveness should encourage wage negotiators to moderate their demands, and the corporate sector to invest in productivity increasing ventures,” he told the Financial Times. “Against this background, monetary policymakers are well advised to look at a very broad set of data and to remain extremely vigilant.”
Jörg Krämer, chief economist at Commerzbank, said the central bank’s handling of wage pressures was “dangerous”.
“What is called catch-up now was called a second-round effect in the old days,” he said.
More bumper pay deals are expected in the coming months.
Germany’s most powerful union, IG Metall, will start its battle for a 7 per cent pay increase for 3.9mn workers in the country’s metal and electrical industry in September.
Collective bargaining is particularly popular in Germany and also covers about 80 per cent of workers across the Eurozone.
Investors are convinced by Lagarde’s message that the behaviour of corporates and households shows that higher pay is unlikely to lead to the dreaded wage-price spiral that haunted western economies in the 1970s, when high pay rises followed oil price shocks and made it more difficult to bring inflation under control.
The ECB president has emphasised that, after rising 4.8 per cent this year, pay deals are likely to be lower in 2025 and “even more so” the following year.
“The [ECB’s] particular focus is on the question to which extent profit margins are absorbing the increase in unit labour costs,” said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management.
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The optimists point to the temporary nature of greedflation — and the current state of the Eurozone economy — to highlight that the risk of history repeating itself today is low.
Isabella Weber, a professor at the University of Massachusetts Amherst and one of the first economists to flag the phenomenon, said external shocks such as clogged supply chains and soaring gas prices had created a “window of opportunity” for companies to raise prices without losing market share.
Consumers, meanwhile, could not switch brands owing to shortages of goods and struggled to tell legitimate and excessive price increases apart.
Four years on, supply chain chinks have been ironed out and energy prices are down. Demand is no longer strong. And rates still remain relatively high.
“The overall Eurozone economy is rather weak and we are seeing a margin squeeze as manufacturers are currently unable to pass on higher wage costs to their clients,” said Ulrike Kastens, an analyst at DWS.
Others say the central bank will still have to keep a close eye on how long the momentum for bumper pay deals persists. Research from the Düsseldorf-based Macroeconomic Policy Institute (IMK) shows the gap between profits and labour costs has all but closed.
“At the euro area level, there is not a lot of catch-up potential left,” IMK’s research director Sebastian Dullien told the FT.
Additional reporting by Emily Herbert in London