MNI INTERVIEW: ECB Should Hike In April - IWH's Holtemoeller

Germany’s economy is likely to be shielded from strong second-round inflation effects from the Middle-East crisis by a combination of longer-term wage contracts and firms’ tendency to pass profits from higher prices on to their employees only after a significant delay, a leading economist told MNI.

But with monetary policy still slightly expansionary, the European Central Bank should raise interest rates this month to show it has learned from past mistakes, having been slow to react to upward price pressures following Covid and the Russian energy crisis, said Oliver Holtemoeller, vice-president of the Halle Institute for Economic Research (IWH) and a contributor to the twice-yearly forecast jointly produced by Germany’s leading economic institutes.

“We already have longer-lasting wage contracts in effect, and we do not expect to see any major wage negotiations for the rest of the year,” Holtemoeller said.

“Inflation expectations should also depend on wage developments, and we don't think that wages will increase as strongly as they did in 2022.”

German national accounts data is currently only available up to the fourth quarter to 2025, which Holtemoeller said made it difficult to get a precise sense of firms’ pricing behaviour since the U.S.-Israeli attack on Iran.

Evidence from 2022 - when prices increased more strongly than marginal costs - indicates that so-called “profit inflation” is short lived, with wages rising only afterwards, he said. (See MNI INTERVIEW: German Firms Up Prices More Quickly - Wise Man)

With some exceptions, German firms pass these profits on to their employees in most sectors, but not immediately, Holtemoeller said.

“If they did not then pass on declines in marginal costs, that would imply a decline in labour share. I know there is a debate about that in the U.S., but in Germany the labour share has increased recently and is relatively high.”

JOINT FORECAST

The German government expects inflation to average 2.7% this year and 2.8% in 2027, in line with the institutes’ Spring Joint Economic Forecast, which put it at  2.8% and 2.9%. Growth estimates for 2026 were slashed to 0.5% by the government and to 0.6% by the institutes, with both expecting 0.9% in 2027.

Data from the European Commission’s monthly survey suggest Germans are “really negative about the economic situation of the country, but when it comes to their personal situation, their views are more balanced. So there is a huge discrepancy between the two,” Holtemoeller said.

A longer-lasting interruption in global supply chains than is baked into the Joint exercise, which used market assumptions for gas and oil prices, would amplify inflationary pressures and hit consumption demand more strongly, he said, with companies already sceptical about the future development of the economy, particularly in energy-intensive sectors.

“This has piled up from the pandemic, the Russian aggression towards Ukraine, and now the latest shock. It’s one shock after another in a relatively short time, and this has an effect on their investment decisions. It’s not just a real economic problem, it seems also to be a psychological problem.”

ECB HIKES

Holtemoeller said market expectations for two ECB rate hikes this year are broadly in line with Joint Economic Forecast assumptions, though with the neutral rate of interest likely to be slightly higher than the level implied by current money market rates of around 2% and a medium-term inflation target of 2%, it would make sense to tighten sooner, rather than later.

“It’s absolutely important that the central bank makes clear that it will fight against inflation, so communication is key. In the end, it could come down to how credible is ECB communication in the light of recent experience,” he said.

“I would lean towards acting fast, just to give a signal. Inflation expectations have been rising, so if monetary policy does nothing then that is expansionary. For that reason I would be in favour of an April hike.”