April 4, 2012

Draghi Tested by German Wage Hikes

Policy forcing gap wider between haves and have-nots

European Central Bank (ECB) President Mario Draghi is in the hot seat over his continuing uniform euro zone policy aimed at controlling inflation. Low interest rates have benefited Germany to the exclusion of weaker countries, and workers there are about to reap the benefits of prosperity with substantial wage increases even as other nations force wages down and cut employment.

Bloomberg reported Wednesday that the ECB is continuing to hold its benchmark interest rate at 1%, despite the fact that the policy does not evenly benefit all euro zone members. Even as prices fall elsewhere, in Germany they are increasing, with inflation on the rise. Weak demand and tough austerity measures in debt-ridden countries are the opposite of conditions in Germany, where the economy is strong and workers are able to ask for raises that some economists say are only surprising in that they took so long.

Christian Schulz, senior economist at Berenberg Bank in London, was quoted saying, “Early signs of wage inflation and rising house prices in Germany will make some hawkish Governing Council members nervous.” But he added that it was still too early to start removing support for banks and “the overall weak economy easily warrants continued low interest rates.”

The German economy, which increased 3.7% in 2010 and 3% in 2011, is expected to continue to grow in 2012, albeit more slowly, despite the region’s economic slowdown. Other countries are not so fortunate, with Belgium, Cyprus, Greece, Italy, the Netherlands, Portugal, Spain and Slovenia all contracting. Unemployment in Germany is at a 20-year low and workers are looking for better pay.

The largest labor union in Europe, IG Metall, has about 3.6 million workers. Those workers are looking for a pay increase of 6.5%. The Ver.di union, which represents Germany’s 2 million public service workers, has negotiated a raise of 6.3% over two years—the most the union has won for its members since 1992.

Klaus Baader, an economist at Societe Generale in Hong Kong, was quoted saying, “The agreement will likely mark a turning point in wage developments in Germany after years of wage restraint. Given the robustness of Germany’s economy and the continued decline in unemployment, the fact that wage growth is rising is not surprising. If anything, it is surprising it has taken so long.”

However, the policy that has been so good for Germany is not helping the other nations in the currency bloc. Carsten Brzeski, an economist at ING Group in Brussels, was quoted saying, “While the German wage deals are good news for workers, Draghi is unlikely to be popping the champagne corks. ECB policy is inappropriate for each individual country in the euro area; it’s too loose for Germany and too restrictive for the periphery. It could end up making the divergences even bigger.”

Germany is trying to boost domestic spending to promote growth, rather than relying so heavily on exports; to that end, some economists say the wage increases are part of a necessary rebalancing. But at the same time Greece has cut its minimum wage by 22%, which makes many of its own problems worse.

Holger Sandte, chief economist at WestLB Mellon Asset Management in Dusseldorf, said in the report that “the ECB is in a dilemma. It’s not an optimal currency area. The economy is terrible in some parts and okay in others, and prices are diverging.”

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