Recent wage negotiations could push inflation closer to the European Central Bank's target in a few years.

Germany, the eurozone's largest economy, raised its official 2018 GDP growth forecast to 2.4% from 1.9% previously. The upward revision matters more in Germany than many other countries because of the role the official forecast plays in the budgetary process. The economy may be benefiting from the inflow of migrants over the past few years, partly because many of these new arrivals are highly skilled engineers, doctors, and other professionals.

So perhaps Germany alone, one of the best performing economies in the region, could get to inflation at the ECB's target in a couple of years.

Germany is beginning to show some signs of overheating. Local unions are pushing for higher wages, but inflation risks remain very small. IG Metall, the country's most powerful labor union, called for a 24-hour strike after a fifth round of failed talks with employers. This is unusual because deals were previously reached after three or four rounds of negotiations. We can't recall the last time IG Metall called a strike. So, are we seeing the Philips curve in action in a unionized economy? Is labor militancy a sign that wages are about to move higher in Europe even though unemployment remains quite high? The answer is no.

IG Metall asked for an 8% pay increase over 27 months, while employers offered a 6.8% raise, according to German press reports. In annual terms, this means the union was asking for a 3.6% raise and employers were offering a 3% pay increase. Even if union workers get their full request, it hardly seems likely to break the bank.

Union wages linked with economy

There's a link between IG Metall wages and wages in the economy. If workers get a 3.5% pay increase, wages in the economy are likely to increase by about 2.5%. With productivity growth at around 0.7%, it would suggest wage costs are rising by about 1.8%. When you include some non-wage benefits, wage costs may increase to 2.0%. Therefore Germany, one of the best performing economies in the region, could see inflation at the ECB's target in a couple of years. Still, a wage-price spiral does not seem about to burst into view.


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