Wages in China, the euro zone’s largest economy, are rising at the fastest pace this century, raising concerns among some economists about an expected interest rate cut by the European Central Bank next month.
Data published on Tuesday by trade union think tank WSI showed that negotiated wages in Germany are expected to rise 5.6% in 2024 based on contracts agreed between January and June, which would be the fastest real wage growth since records began in 2000.
While the increase is well above rate-setters’ overall inflation target of 2 percent, policymakers in Frankfurt are factoring in “high” wage growth into their forecasts.
The ECB’s calm in the face of upward pressure on wages stems from its belief that workers whose purchasing power has been eroded by inflation are still “catching up.” Even taking into account this year’s 5.6% wage increase, it only compensates for half of the losses for German workers between 2021 and 2023.
European Central Bank President Christine Lagarde in June cited an agreement to raise wages for German civil servants by 12% – the first in three years – as an example.
“You can imagine that an agreement that would be cut in 2024 and cover (the loss of purchasing power) in 2021, 2022 and 2023 would obviously be quite significant,” she said.
Markets are now seeing a more than 90% chance of a further 25 basis point cut in deposit rates in September, following a cut from 4% to 3.75% in June.
Policymakers’ confidence is being bolstered by a reversal of a phenomenon known as “greedflation,” which means businesses are finding it harder to pass on extra labor costs to customers.
Policymakers believe that in the early days of the pandemic, companies took advantage of a combination of high input costs and strong consumer demand to raise prices and boost profit margins. Now, growth is stagnating and profit margins are likely to shrink, while unemployment remains low and workers can demand higher wages.
But not all rate-setters are convinced the ECB can avoid what Lagarde calls “retaliatory inflation.”
Austria’s hawkish central bank governor, Robert Holzmann, the only Governing Council member who did not support a rate cut in June, said rising labour costs in the euro zone would squeeze the region’s competitiveness.
“The potential loss of competitiveness should prompt wage negotiators to soften their demands and encourage the corporate sector to invest in productivity-enhancing projects,” he told the Financial Times. “Against this backdrop, monetary policymakers should consider a wide range of data and remain extremely vigilant.”
Jörg Kraemer, chief economist at Commerzbank, said the central bank’s response to wage pressures was “dangerous”.
“What is now called catch-up used to be called the second-round effect,” he said.
Further high-stakes wage negotiations are expected in the coming months.
IG Metall, Germany’s most powerful trade union, will begin fighting in September for a 7 percent wage increase for the country’s 3.9 million workers in the metal and electrical industries.
Collective bargaining is particularly widespread in Germany, and covers around 80% of workers across the eurozone.
Investors are being persuaded by Ms. Lagarde’s message that the behavior of companies and households means wage increases are unlikely to lead to the terrible wage-price spiral that plagued Western economies in the 1970s, when wage increases surged after an oil-price shock and made inflation hard to contain.
The ECB president stressed that after 4.8% wage growth this year, wages are likely to fall in 2025 and “further” the following year.
“A particular question they’re looking at is the extent to which profit margins are absorbing increases in unit labour costs,” said Frederic Ducrozet, head of macroeconomic research at Pictet Wealth Management.
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Optimists point to the temporary nature of greed flation and the current state of the eurozone economy, emphasizing that the risk of history repeating itself is low today.
Isabella Weber, a professor at the University of Massachusetts Amherst and one of the first economists to identify the phenomenon, said external shocks such as supply-chain disruptions or high gasoline prices create an “open window” for companies to raise prices without losing market share.
Meanwhile, consumers were unable to switch brands due to shortages and had a hard time distinguishing between legitimate and excessive price increases.
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Four years on, supply chain flaws have been ironed out and energy prices have fallen, but demand is no longer strong and rates still remain relatively high.
“The overall weakness in the euro zone economy is putting pressure on profit margins as manufacturers are unable to pass on wage increases to customers,” said DWS analyst Ulrike Kastens.
Others say central banks still need to keep a close eye on how long the momentum for higher wage negotiations can last.The gap between profits and labor costs has almost been closed, according to a study by the Duesseldorf-based Institute for Macroeconomic Policy Research (IMK).
“At the euro area level, there is not much room left to catch up,” Sebastien Durian, research director at IMK, told the Financial Times.
Additional reporting by Emily Herbert in London
