Eurozone rate cuts questioned as German wages rise

Wages in the eurozone’s biggest economy are rising at their fastest pace this century, fuelling concerns among some economists about the European Central Bank’s expected interest rate cut next month.

Negotiated wages in Germany are expected to jump 5.6 percent in 2024, based on agreements reached between January and June, according to data published Tuesday by WSI, a trade union think tank. The wage increase, in real terms, will be the fastest since records began in 2000.

Although the increases far exceed rate-setters’ overall inflation target of 2 percent, policymakers in Frankfurt have included “high” wage growth in their forecasts.

The ECB’s calm on wage pressure is due to the conviction that workers are still “catching up” from the purchasing power eroded by inflation. Even taking into account this year’s 5.6% wage increase, only half of the losses of German workers between 2021 and 2023 have been offset.

In June, ECB President Christine Lagarde cited as an example a 12 percent pay deal for public sector workers in Germany, the first in three years.

“You can imagine that an agreement that is cut in 2024 and that covers [lost purchasing power in] “The years 2021, 2022 and 2023 will obviously be very important,” he said.

Markets are pricing in a more than 90 percent chance of another 25 basis point cut in September, following the deposit rate cut from 4 percent to 3.75 percent in June.

Policymakers’ confidence is boosted by the reversal of a phenomenon known as “greedflation”, which means that companies are finding it harder to pass on additional wage 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 stalled, profit margins look set to shrink. Meanwhile, unemployment remains low, meaning workers can push for wage increases.

However, not all rate-setters are convinced that the ECB will succeed in avoiding what Lagarde has called “tit-for-tat inflation.”

Robert Holzmann, the hawkish governor of Austria’s central bank and the only member of the rate-setting governing council who did not support a cut in June, said rising labour costs in the eurozone would weigh on the region’s competitiveness.

“The potential loss of competitiveness should encourage wage negotiators to moderate their demands and the business sector to invest in productivity-boosting initiatives,” he told the Financial Times. “Against this backdrop, policymakers should look at a very broad set of data and remain extremely vigilant.”

Jörg Krämer, chief economist at Commerzbank, said the central bank’s handling of wage pressures was “dangerous”.

“What is now called recovery was previously called the second-round effect,” he explained.

More extraordinary wage agreements are expected in the coming months.

Germany’s most powerful union, IG Metall, will begin its battle in September for a 7 percent pay rise for 3.9 million workers in the country’s metal and electrical industry.

Collective bargaining is especially popular in Germany and also covers around 80 percent of workers in the eurozone.

Investors are encouraged by Lagarde’s message that the behaviour of businesses and households shows higher wages are unlikely to lead to the dreaded wage-price spiral that plagued Western economies in the 1970s, when high wage increases followed oil price shocks and made inflation difficult to control.

The ECB president stressed that, after having increased by 4.8% this year, wage agreements are likely to be lower in 2025 and “even lower” the following year.

“He [ECB’s] “Particular attention is being paid to the extent to which profit margins are absorbing rising unit labour costs,” said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management.

Optimists point to the temporary nature of greedflation — and the current state of the eurozone economy — to stress 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 spot the phenomenon, said external shocks such as congested supply chains and rising gas prices had created a “window of opportunity” for companies to raise prices without losing market share.

Meanwhile, consumers were unable to switch brands due to product shortages and had difficulty distinguishing between legitimate and excessive price increases.

Four years later, supply chain issues have been resolved and energy prices have come down. Demand is no longer strong and tariffs remain relatively high.

“The overall eurozone economy is quite weak and we are seeing margin compression as manufacturers are currently unable to pass on higher wage costs to their customers,” said Ulrike Kastens, an analyst at DWS.

Others say the central bank will still have to keep a close eye on how long the push for extraordinary wage deals will persist. Research by the Düsseldorf-based Macroeconomic Policy Institute (IMK) shows the gap between earnings and labour costs has virtually closed.

“At the eurozone level, there is not much potential for recovery left,” IMK research director Sebastian Dullien told the Financial Times.

Additional reporting by Emily Herbert in London