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German Pay Deal May Impact ECB's Inflation Strategy

According to analysts, Germany's public sector workers have secured a "very generous" pay rise, which could complicate the European Central Bank's (ECB) fight against inflation.

European Central Bank
European Central Bank

Details of the Proposed Deal

The proposed deal will provide 2.5 million employees in Europe's largest economy a permanent 5.5% increase next year and a series of one-off payments over the next 12 months to help manage the rising cost of living.

Wage Growth and ECB's Forecast

The deal sets a precedent for other pay negotiations. It may threaten the ECB's prediction that wage growth will peak this year, which supports its expectation for eurozone inflation to return to the central bank's 2% target by 2025.

Economists React to German Pay Deal

Economists such as Natixis' Dirk Schumacher and Axa's Gilles Moec have commented on the implications of the German pay deal, suggesting that it could raise concerns at the ECB and significantly increase aggregate wage growth.

ECB's Projections and Policy Debates

The ECB forecasts wage growth across the euro-using countries to average 5.3% this year before declining to 4.4% next year and 3.6% in 2025. However, some policymakers have challenged this forecast as too benign.

Interest Rate Hike Expectations

Holger Schmieding, a chief economist at Berenberg, suggests that the German deal gives ECB policy hawks another reason to raise critical rates, with a quarter of a percentage point increase widely expected next week.

Falling Real Wages Context

Some economists note that the German public sector pay agreement comes after a period of falling real wages, when prices grow faster than salaries, leading to arguments that the deal is reasonably front-loaded.

Purchasing Power and Future Outlook

Marcel Fratzscher, founder of the DIW think tank, estimates that public sector workers will face a 6% drop in purchasing power by the end of next year, assuming 6% inflation in 2023 and 3% in 2024, and it may take another five years for wages to recover this loss.