MNI INTERVIEW: ECB Too Confident On Rates-Holtemoeller

The European Central Bank is likely to keep rates at current levels beyond the second quarter of next year, a leading German government adviser told MNI, but he added that it had been unwise to commit to keeping policy unchanged for an extended period.

“I think monetary policy rates will stay where they are until late 2024,” said Oliver Holtemoeller, vice president of the Halle Institute for Economic Research (IWH), and a member of the Federal Stability Council Advisory Board. “There could be a further increase in inflation rates due to geopolitical events, energy prices or other scenarios, but it's not my baseline.”

But Holtemoeller said it had been wrong to guide for rates to stay steady. The ECB has said policy rates will be set at sufficiently restrictive levels for as long as necessary, while President Christine Lagarde has indicated no changes should be expected for two quarters.

“There are clearly scenarios that could lead to a recession in the euro area. Again, it's not our baseline, but I see the risk. Therefore, I think that when it comes to the ECB, what we have seen is that long-term commitments are in the end not credible.”

GERMAN WAGES

With the ECB “vigilant” towards signs wages could feed inflation, Holtemoller expected nominal pay rises in Germany of 6% in 2023 and 3% in 2024 - above the 2% inflation target but not fueling a wage-price spiral. (see MNI INTERVIEW: Wages Set To Refuel German Inflation-ZEW Chief).

“We expect that real wages will catch up to the level of late 2021, but to make this happen nominal wages increases have to be larger than the inflation rate, which is still elevated.”

Despite higher labour costs many firms have enjoyed significant boosts to profit margins since the 2022 energy crisis, and recent upticks in bankruptcies is merely a return to the pre-pandemic trend, he said.

“There are regional differences, and differences between small and large firms,” Holtemoeller said. “But overall, prices and profits have risen further than costs, so in many cases firms will be able to pay the higher wages. As in the case of insolvencies this is a normalisation now; first profits have been increasing and now wages are catching up.”

Still, low levels of productivity and innovation will weigh on Germany’s economy over the medium- to long-term, he said, noting that while growth in output is back at pre-pandemic levels, growth per employee is “way below,” after 500,000 workers joined the labour force over the same period. European productivity growth overall is low, he added.

“If you compare productivity growth in the U.S. to productivity growth in continental Europe, then you will see that the main driving force behind productivity growth in the U.S. is the services sector, and continental Europe is lagging behind,” he said. “A second growth driver is capital accumulation, which is driven by investment. If you talk to firms in Germany, if you look into the investment data, then the bottleneck is again productivity.”

Germany’s economy, already expected to shrink 0.6% this year according to a forecast by leading economic institutes in September, before a November decision by the Constitutional Court invalidated a major part of the government’s 2024 budget, will be “very low” next year, Holtemoeller said.

ADDED UNCERTAINTY

“After the sentence of the Constitutional Court, maybe the outlook is even more problematic,” he said, though he added that a new Budget to be presented in December made it difficult to quantify the effect on output next year and in 2025. (See MNI INTERVIEW: Court Ruling Shaves 0.5% From German GDP-Demary)

The ruling adds uncertainty, which is “problematic for firms who want to invest, and for households who need to renovate their houses as part of the energy transition,” Holtemoeller said.

It has also cast doubt on a planned five-year, EUR200 billion energy subsidy for industry, though Holtemoeller called this “an opportunity to rethink energy policy.”

Raising CO2 prices would be more effective in lowering emissions, and revenues from such a policy could support poorer households and existing firms, as well as help startups, he said, adding. “Large firms are usually not at the center of innovation.”