Germany's wage growth cannot hide the economic weakness. Is the European Central Bank expected to accelerate interest rate cuts?

According to Zhitong Finance, research shows that Germany's inflation-adjusted wage levels are set to grow at the fastest pace in over a decade this year. The Hans Boeckler Foundation's Institute of Economic and Social Sciences (WSI) stated on Friday that collective bargaining wages will rise by 5.5% in 2024, with a real value increase of 3.2%.

The wage developments in Germany and the entire Eurozone are currently under special scrutiny for two reasons: the European Central Bank believes that a slowdown in wage growth is a prerequisite for achieving the 2% inflation target sustainably and for further interest rate cuts. Meanwhile, healthy wage growth is crucial for supporting consumption and the struggling economy.

In the third quarter of this year, wages negotiated by labor and management in Germany increased by 8.8% compared to the same period last year, marking the fastest growth since 1993. However, this growth rate is unlikely to be sustained, as a key agreement recently reached between the German Metalworkers' Union (IG Metall) and the manufacturing sector has locked in relatively moderate wage growth for the next two years. According to WSI data, inflation-adjusted negotiated wage levels are far below the peak levels of 2020.

Thorsten Schulten, a researcher at the Hans Boeckler Foundation affiliated with the German Trade Union Confederation, stated: "The strong growth in real wages this year makes it possible for Germany to recover about half of the purchasing power loss from the previous three years. The decline in employee purchasing power is a key reason for the weak development of the German economy. Although employee income has rebounded this year, there is still much work to be done."

Nevertheless, the German labor market seems to be losing momentum. Data released by the German Employment Research Institute on Thursday showed that job vacancies in Germany have been on a downward trend for two years, indicating a decline in labor demand, reflecting the economic slowdown in Europe's largest economy. The IAB reported that there were 1.28 million job vacancies in the third quarter, down from a record 1.98 million two years ago, marking the seventh consecutive quarter of decline.

Alexander Kubis, a labor market researcher at the IAB, stated: "Overall, the labor market has clearly cooled compared to the previous year." In 2024, Germany will be the worst-performing country among the wealthy democracies of the G7 for the second consecutive year. The IAB noted that the number of job vacancies decreased by 58,100 compared to the second quarter, a decline of about 4%. Compared to the third quarter of 2023, the decline was even greater, with a reduction of 446,500, a drop of about 26%.

Additionally, several recently released data points continue to show weak economic growth in Germany. The weakness of Germany, the "locomotive" of the European economy, has sparked market speculation about whether the European Central Bank will take more significant interest rate cuts.

Manufacturing slump drags down German economy, service sector weakens

Germany's industrial production unexpectedly fell in October, crushing hopes that the key sector of the largest economy in Europe might be slowly overcoming its sluggishness. Germany's seasonally adjusted industrial output fell by 1% month-on-month in October, while the market had expected a growth of 1%. The German Federal Statistical Office stated on Friday that the decline was mainly due to energy production, with the "automobile industry also negatively affected." Carsten Brzeski of ING Group stated, "The trend of decline in German industry shows no signs of ending. This is a very weak start to the fourth quarter, increasing the risk of a winter recession in Germany."

Friday's data echoed earlier data from this week. The data showed a decline in factory orders in October. The recession in manufacturing is putting pressure on the German economy, which is set to contract for the second consecutive year. The President of the German Central Bank, Joachim Nagel, even warned that if Donald Trump is elected president again and implements his threatened trade tariffs against China and other countries, Germany's GDP could shrink in 2025.

German industry is facing external pressures, such as the loss of energy supplies following the Russia-Ukraine war and weak demand. Domestically, the shortage of skilled workers is a drag. Due to the poor economic outlook, some companies have announced layoffs of thousands, particularly in the automotive sector, which is central to German manufacturing, raising concerns about a downward spiral in the economy.

Affected by the collapse of the government and the threat of trade tariffs following Trump's re-election as U.S. president, Germany's IFO Business Climate Index fell from 86.5 a month ago to 85.7 in November, worse than economists' forecast of 86. Both the Ifo expectations and current conditions indicators declined, indicating a deterioration in the business outlook for Germany in November, continuing the sluggish trend.

A survey by S&P Global last week showed that the contraction in private sector activity in Germany in November was faster than in October, with both the services and manufacturing indices falling below 50 (the dividing line between expansion and contraction).

Third-quarter GDP was also revised down. The statistical agency stated that the decline in exports suppressed growth driven by consumer and government spending. The German Central Bank does not hold much hope for economic growth in 2024. The central bank predicts that the economy will stagnate in the last three months before a mild recovery next year.

Economists' Expectations for ECB Rate Cuts Heat Up

The European Central Bank may provide support, as it could lower borrowing costs again next week and further cut rates in 2025. Economists estimate that despite rising incomes, consumption remains sluggish, and Germany's output will shrink for the second consecutive year in 2024. Since June, the European Central Bank has cut rates three times, and it is widely expected to do so again at its meeting in Frankfurt next week.

According to a survey, analysts expect the European Central Bank to lower the deposit rate by 25 basis points at each policy meeting next week and before June, to 2%, down from previous expectations of reaching this level a year later. This adjustment in expectations also reflects the deep-seated issues in the Eurozone economy, with both the services and manufacturing sectors in contraction and businesses and consumers facing uncertainty

Widespread pessimism has sparked market speculation about whether the European Central Bank will implement more significant interest rate cuts. However, despite a few officials being open to this idea, most officials, including some senior doves, still support a gradual approach to rate cuts. Economists agree with this, but only JP Morgan predicts a 50 basis point rate cut in December.

Bill Diviney from ABN AMRO pointed out: "The case for policy easing is very strong, but the urgency for a 50 basis point cut is not apparent at this moment." A more likely scenario is that the European Central Bank will make adjustments in its official policy statement, with the current commitment being to "maintain sufficiently restrictive rates when necessary."