Inflation jitters

The specter of a wage-price spiral forming in Germany is spooking consumers and threatens to undo the gains in competitiveness that have underpinned a recovery in Europe's largest economy. German inflation accelerated to 3.1 percent in March, just shy of its highest level since the end of 1993, and touching a nerve in a country whose national psyche is scarred by the folk memory of hyperinflation between the world wars.

"Inflation Angst" ran the front-page headline in mass-selling daily Bild on April 18, reflecting consumers' price worries.

The legacy of the 1920s, when a wheelbarrow full of money was needed to buy a loaf of bread, has left German consumers particularly sensitive to prices.

As in other countries, inflation is now being pushed up by the increased cost of foodstuffs and energy, but above-inflation wage deals threaten to pull prices higher still.

Dubbed a "mega wage year" by Germany's biggest industrial union, 2008 has already delivered the biggest pay raises in 16 years for workers in the public sector and the steel industry.

Signs are growing that price hikes will follow as a direct result of this year's wage increases, potentially unleashing the wage-price spiral that the ECB dreads.

"The extra (wage) costs will leave some local authorities no choice but to raise the charges and prices for their services, for example in local public transport or garbage collection," says Stephan Articus, chief of the German Association of Cities.

Rate rise?

This year's public sector wage agreement, which affects some 2 million workers, provides for a 3.1 percent wage hike plus an increase of 50 euros ($79.14) a month - a deal trade union Verdi says equated to a 5.1 percent rise.

The ECB, which aims to keep inflation just below 2 percent in the euro zone, is watching German wage deals closely. Inflation in the bloc hit a record 3.6 percent in March.

ECB Governing Council member Axel Weber told Sunday's Welt am Sonntag newspaper that the central bank needed to make sure higher prices did not lead to higher wages: "Because that would inevitably start off a wage-price spiral," he says.

Economists from a panel of leading economic institutes says last week they expected negotiated wages per hour to increase on average by 2.2 percent in 2008 and by 2.6 percent in 2009.

"Regarding a wage-price spiral, I do not yet think it is under way, but the danger is very much there," says Joachim Scheide of the Kiel-based IfW, one of the panel of institutes.

Backlash

In the last two years, Germany has enjoyed its strongest increase in economic activity since reunification in 1990 and workers want a greater share of the success after years of wage moderation that helped boost firms' profitability.

"There is a backlash now, which is normal," says Bank of America economist Gilles Moec. "In Germany, this increase in public (sector) wages is in a way a fiscal stimulation... That's dangerous if it goes on into a full-blown spiral."

While rising wages and falling unemployment should mean Germans have more money to spend, their angst about inflation, welfare reforms and the economic outlook has stoked the savings rate, which is running at around 10 percent of income.

"The dent to purchasing power from increases in the price of energy and foodstuffs has probably - together with insecurity with regard to economic expectations - put a brake on private consumption," the Finance Ministry says in a recent report.

"A further strong rise in prices would... have a dampening effect (on consumption)," it says in the April monthly report.

With the contribution to growth from foreign trade expected to fade this year as the world economy slows, economists have been looking to private consumption to take over as a driver of the economy - an expectation that has not yet materialized.

German retail sales posted their biggest decline in over a year in February, falling by 1.5 percent on the month.

Rising wages also risk undoing the gains in competitiveness that helped Germany retain its title last year as the world's biggest exporter of goods.

However, economists agreed that unions would probably tone down their wage demands next year.

"Now it's time for payback, but the unions are also capable of understanding that if there is a slowdown down the road in the second half of 2008, in 2009, it will be time to be more reasonable," says Moec at Bank of America.

"I think this year is a bit exceptional," added Werner Eichhorst at the Bonn-based Institute for the Study of Labor. "The outlook for a weaker business cycle next year will force trade unions and wage earners to be more moderate again."

Agencies

(China Daily 04/28/2008 page11)