Is payday over for German workers?

The European Central Bank (ECB) on Wednesday published its quarterly negotiated wages indicator for Q3, and while this is only one indicator the ECB uses to determine wage inflation across the Eurozone, the growth rate of 5.4% was the highest since the early 1990s.

With goods inflation now down at pre-pandemic levels in line with the normalisation of supply chains, the services sector is to blame for inflation (and particularly core inflation) still being above target in many countries. Wages are typically the main variable cost for services companies, and workers demand to at least keep up with elevated inflation levels to maintain their purchasing power. Higher wages can create a feedback loop if consumers increase spending and provoke another round of price increases, and central banks are wary of this so-called “wage-price spiral” as it can perpetuate an inflation shock rather than it dissipating with time.

The main driver of the strong wage rises in Q3 was Germany. The Bundesbank’s monthly report on the German economy published a few days ago showed negotiated wages increased by 8.8% in Q3, the country’s own highest growth rate since 1993. In terms of sectors, settlements in the retail, wholesale and foreign trade sectors were the largest contributors.

As scary as these numbers sound in the context of economic growth being essentially zero for several quarters in Germany, we do not think this is representative of the trend going forward. The ECB release doesn’t offer much detail, but governing council member Francois Villeroy de Galhau described the jump in Q3 as a “somewhat backward-looking indicator mainly driven by the lagged effects of past negotiations in Germany”, adding that these numbers were already accounted for in the ECB’s projections. The Bundesbank’s report offered similar comments, noting that annual wage increases in the metals and electrical engineering industry in Q3 were fairly moderate at 2.2%, unsurprising given the strong deterioration in that sector’s economic situation. “Given the prolonged period of economic weakness and significantly lower inflation rates, the other forthcoming wage negotiations are, on the whole, expected to result in distinctly lower agreements than in the past two years,” the report added.

The fact that the ECB and the Bundesbank do not seem too worried after seeing the highest wage inflation figures in 30 years highlights just how different labour markets are in Europe compared to the US and, to a lesser extent, the UK. It is worth noting that Germany’s 8.8% increase is calculated on the basis of “negotiated” pay rates; data comes from roughly 500 collective wage agreements in approximately 40 sectors and comprises 20 million workers, in other words half of all employees in Germany. The nature of these wage deals means that wages tend to show a considerable lag to inflation. In other words, workers see their real wages getting squeezed and then unions look to negotiate a multi-year wage increase deal, but the process takes time. In the US, where the labour market is a lot more flexible, wages adjust a lot faster.

While the headline numbers are bad, we think this is indicative of wages catching up with past inflation and does not represent a trend going forward. It is also worth mentioning that other wage indices haven’t displayed the same behaviour. The widely followed Indeed Wage Tracker, for example, showed Eurozone wage growth at 3.25% in October (it was 4.4% a year earlier). As a result, we do not think these numbers alter the course for the ECB, which is towards lower rates in coming quarters.