ECB Insight: German Job Market Strength Raises Inflation Stakes

30 June 2021

By David Barwick – FRANKFURT (Econostream) – The strong performance of the euro area’s largest national labour market this month raises the stakes for the European Central Bank, suggesting as it does that the missing piece of the medium-term price stability puzzle could conceivably fall into place after all.

As reported on Wednesday, German unemployment dropped by a seasonally adjusted 38,000 persons in June, well above market expectations, leaving the unemployment rate at 5.9% following the previous month’s downward revision. The number of short-time workers for the latest reporting month of April also dropped anew.

The rapid improvement of Germany’s labour market could, if it continues, call into question the weak-wage-growth mantra monetary authorities have been relying on to dispel fears that the current surge in euro area headline inflation could prove more than a transitory phenomenon.

Answering questions during an appearance before the Committee on Economic and Monetary Affairs of EU Parliament on June 21, ECB President Christine Lagarde said that monetary authorities had to be ‘extremely attentive to wage negotiations, which can be of serious consequences’. However, wage developments are currently not ‘at a level that would lead to stronger underlying inflation factors’, she said.

It is understandable that wage developments at this stage are not such as to generate strong underlying inflation; economies are still emerging from a severe crisis and uncertainty, as the ECB underscores at every turn, remains elevated.

The ECB knows this full well. In an interview on June 17, Chief Economist Philip Lane observed that ‘[i]t’s very difficult, when you have unemployment so high, to see very strong wage pressure. The wage negotiations we do see are coming in low, which is not surprising given the slack in the labour market.’

If however general economic conditions develop positively, as is expected by the ECB as well, more robust job markets would be a natural consequence. And then, especially against the backdrop of already high headline inflation, second-round effects on wages would constitute a further upside inflation risk the ECB could not ignore.

The contribution that the region’s largest economy will make to such a scenario is uncertain. Bundesbank President Jens Weidmann only Monday said that second-round effects ‘in the form of significantly stronger wage growth or noticeably higher inflation expectations’ would be ‘crucial’ for persistently high inflation, but that ‘this is not currently on the horizon’. Ten days previously, Weidmann said of excessive wage settlements that ‘[w]e have no evidence of this at present.’

But again, it is early days yet. In its latest monthly report however, issued on June 21, the Bundesbank offered clear reason to think at least that the German labour market recovery would continue. ‘Hiring readiness indicators increasingly show that a recovery in the labour market is expected in the near future. … The IAB Unemployment Barometer rose to an extremely optimistic level in May; unemployment is expected to fall rapidly in the next three months’, the central bank reported.

Moreover, the Bundesbank suggested that ‘stronger wage increases’ would contribute to an increase in German core inflation all the way to 1.7% by 2023.

That the ECB dismisses the threat of sustained higher inflation is not surprising, given its fixation on extending policy support for as long as it possibly can. Although Econostream understands that ECB Vice President Luis de Guindos did not mean to send any new signals on Monday, his words on the subject take on more meaning in light of German labour market strength:

‘In any case, we are attentive to incoming information to assess whether the temporary increase in inflation gives rise to second round effects that could translate into a more permanent development’, he said.