LDN - Business

Germany's 'very generous' pay deal may complicate ECB's inflation fight

[April 24, 2023] By Francesco Canepa and Balazs Koranyi

FRANKFURT (Reuters) - The "very generous" pay rise secured by Germany's public sector workers may complicate the European Central Bank's fight against inflation, analysts said on Monday.

The proposed deal will give 2.5 million employees in Europe's largest economy a 5.5% permanent increase next year, on top of a series of one-off payments over the next 12 months to help them deal with a surge in the cost of living.

That will set an important precedent for other pay talks, and could threaten the ECB's forecast that wage growth will peak this year, which underpins its expectations for euro zone inflation to come back to the central bank's 2% target by 2025.

"The permanent increase next year may raise some eyebrows at the ECB because wages were supposed to peak this year," Natixis economist Dirk Schumacher said.

Gilles Moec, chief economist at French insurer Axa, called the proposed deal "very generous" and Mark Cus Babic, an economist at Barclays, said it "could significantly increase aggregate wage growth".

The ECB projects that wage growth across the 20 countries that use the euro currency will average 5.3% this year before declining to 4.4% next year and 3.6% in 2025.

But the ECB's account of its March meeting shows this forecast was challenged by some policymakers as too benign when it was presented to them last month.

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A protestor holds a placard reading 'Nancy (Nancy Feser, German Minister of Interior) give us the money' as people demonstrate in front of 'Landungsbruecken' at the harbour during a nationwide strike called by the German trade union Verdi over a wage dispute in Hamburg, Germany, March 27, 2023. REUTERS/Fabian Bimmer

Holger Schmieding, chief economist at Berenberg, said the German deal gave policy hawks at the ECB "another argument to raise key rates at least twice more, and at least not to rule out a new 50 basis point move on May 4".

The ECB is widely expected to raise rates by a quarter of a percentage point next week, slowing the pace of tightening due to lingering uncertainty about the financial sector and lagged effects from past increases in borrowing costs.

Other economists noted the German public sector pay agreement followed a period of falling real wages, when prices grow faster than salaries.

"Doves may argue that the deal comes after a period of wage restraint and is reasonably front-loaded," Christian Schulz, an economist at Citi, said.

Marcel Fratzscher, a former ECB economist who has since founded the DIW think tank, estimated the deal will leave public sector workers nursing a 6% drop in purchasing power by the end of next year, assuming 6% inflation in 2023 and 3% in 2024.

"This means that it will probably take at least another five years for public sector wages to recover this loss of purchasing power and for employees to have the standard of living they had in 2021," Fratzscher said.

(Reporting By Francesco Canepa; Editing by Catherine Evans)

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