ECB’s pleas for restraint at odds with mood

Eurozone wage developments are being watched warily by the European Central Bank, which has signalled its readiness to raise interest rates if inflation shows any sign of spinning out of control.

But its pleas for wage restraint – likely to be repeated by Jean-Claude Trichet, ECB president, after Thursday’s interest-rate setting meeting – have not found an echo in national capitals.

The Frankfurt-based institution would risk political isolation if it made good its threat to raise official borrowing costs at a time when growth across the 15-country region is slowing and the euro is at a record high.

Meanwhile, companies’ profits, not pay packets, are widely-seen as having gained most in the past few years, an argument that strengthens trade union’s hands. Profits hit an all-time high of 40.7 per cent of eurozone gross domestic product in the third quarter of last year, according to UBS Investment Research.

Even talking about higher rates might appear politically provocative, especially when the US Federal Reserve and Bank of England are cutting borrowing costs in anticipation of tougher economic times. But at a six-year high of 3.1 per cent in December, eurozone inflation is way above the ECB’s target – a rate “below but close” to 2 per cent.

Not yet 10 years old, the ECB is still burnishing its inflation-fighting credentials. It fears that the temporary “hump” in inflation driven by soaring oil and food prices will become longer lasting if it feeds through into higher pay settlements.

ECB forecasts, released in December, showed inflation returning back below 2 per cent in 2009. But ECB governing council members have stressed that those forecasts assume crucially that there is no general “pass-through” into wage demands. Some members last month voiced support for a pre-emptive rise in interest rates.

Mr Trichet warned senior members of Germany’s ruling Christian Democratic Union last weekend that it was “essential” that wage-setting behaviour “remains unaffected by current inflation rates”.

The ECB would act to “ensure that such ‘second round’ effects ... do not materialise”, he warned.

The problem for the ECB is that its fears about inflation do not fit with the political mood across the eurozone – forcing it to take a more strident tone.

“Politicians are adding to the risk of ‘second round’ effects,” says Holger Schmieding, economist at Bank of America. “That is clearly an argument for [the ECB] not even thinking about cutting interest rates.”

In Berlin, and elsewhere, politicians are arguing that workers should take a larger slice of the economic cake.

Nicolas Sarkozy, the French president, has promised to raise the salaries of public sector workers in return for a reduction in headcount and a reorganisation of career structures. He has also stepped up pressure on companies to talk to unions about the possibility of pay increases, threatening to withhold tax breaks and state aid if company bosses refuse to at least open negotiations with their staff.

In Italy, trade unions opened 2008-09 wage talks this week with a demand for lower taxes and more benefit payments to boost workers’ spending power. Romano Prodi, prime minister, recognises the need for some tax cuts, but wants a deal with the unions that links pay with productivity and gives employers more flexibility.

Such debates have only intensified as inflation has risen, particularly in Germany where consumers appear highly sensitive to rises in food and fuel costs.

The ECB had been “cornered” as a result, said Marco Annunziata, economist at Unicredit.

“The erosion of purchasing power is felt strongly, so it is not surprising that governments across the European Union are sensitive to it.”

A softer Sarkozy

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