UBS AM: German wage growth - highest in the Eurozone

With Eurozone core inflation stuck just below 1% despite the rise in headline inflation, the ECB is looking to wage growth for any signs of emerging underlying price pressures. In the last ECB press conference, President Draghi noted that wage growth was the 'lynchpin of a self-sustained increase in inflation'. At 1.6% y/y in the Eurozone, hourly wage growth so far remains well below its long-ru in average of 2.4%. So where should the ECB look when searching for wage pressures?

Germany holds the key to higher Eurozone wage growth

Across countries, Germany has all the prerequisites for acceleration in wage growth: its unemployment rate is the lowest by some margin (3.8%), the employment rate is well above that in the US and other OECD countries, and the vacancy rate is the secondhighest in the Eurozone. German wage growth indeed is the strongest in the Eurozone, at 2.9% in Q4 2016, almost twice the Eurozone rate. Core inflation at 1.2% is higher than in the Eurozone (0.7%). And yet, German wage growth still looks moderate relative to history, especially considering the tightness of the labour market. Is there more upside in Germany, which could also raise Eurozone wage growth?

Higher inflation and rising minimum wages support nominal wage growth

Headwinds to stronger German wage growth in the recent past, in our view, were low inflation expectations and a large build-up of lower-paid services sector jobs (which have dampened overall wage growth). Going forward, we would look for the increase in headline inflation (and the associated rise in inflation expectations) to support higher nominal wage growth as employees try to defend their real wage gains. And we would expect wages for lower-paid services sector jobs to be impacted by the rise in minimum wages by 4% at the start of this year, which should affect around 20% of all employees both directly and indirectly.

We expect further acceleration in wage growth in Germany

We continue to believe that nominal hourly wage growth is likely to accelerate further, given the tight labour market. At around 3%, nominal wage growth exceeds productivity growth (around 1%), implying that unit labour costs are rising solidly (and stronger than in the Eurozone), suggesting that this should feed into core inflation pressures as the ECB expects. Business surveys are showing increasing price pressures. Overall, we believe that aggregate German wage growth of around 4% (up from around 3% in 2016) would look plausible, given the tightness of the labour market. Companies benefitting from this trend are those with relatively low exposure to German wage inflation and higher exposure to German domestic demand (see Germany: Is the story about to change?).

Wage growth an important indicator for the ECB

ECB President Draghi noted in the press conference following the March Governing Council meeting that wage growth was the 'lynchpin of a self-sustained increase in inflation'. But he also said that 'we haven’t seen yet any significant development on the wages front; that is the key point.' Indeed, looking at the Eurozone overall, hourly wage growth remains low compared to the past, with annual growth of 1.6% year on year in Q4 2016, compared with an average of 2.4% since 2000 (Figure 1). The flipside is stable core inflation, which has been hovering around 0.8% year on year for over a year now (and currently stands at 0.7%). The ECB argued recently that moderate wage growth was primarily a reflection of ample labour market slack and low inflation expectations downwardly impacting wage growth.

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