CORRECTS-MNI INTERVIEW: German Firms Up Prices More Quickly

(Corrects seventh paragraph to make clear revision will be in tenths of a percentage point, not percentage points)

German inflation will rise above 3% in April as firms react aggressively to oil price rises even at the expense of lower sales, while labour market weakness means workers are unlikely to see faster pay rises to compensate, a newly-appointed member of the German Council of Economic Experts (GCEE) told MNI.

“We will have to see how the energy shock feeds into other areas, notably food and electricity, but I would expect inflation to cross the 3% line in April,” said Gabriel Felbermayr, also head of the Austrian Institute of Economic Research (WIFO).

“We are perhaps seeing firms more generally reacting faster than in 2022-2023.”

Companies are in a much stronger position in cyclical terms than at the start of the 2022 energy shock, while long-run structural change - notably the decline of manufacturing - reduces incentives to hoard labour, Felbermayr said in an interview.

“That in turn gives firms a possibility to be more aggressive on the price side even if higher prices mean lower sales, but at the same time there is less reason to retain workers, who are in any case going to have reduced bargaining power.”

AI is likely to depress labour demand in all sectors, Felbermayr said, pointing to an aggressive rebalancing of employers’ trade-off with unions between pay and promises to retain workers or to invest in training and other resources.

UNDERLYING CONCERNS

Flash inflation of 2.7% for March was slightly better than the 2.9% analysts expected, Felbermayr noted, though it could yet be revised upwards by “a [tenth of a] percentage point or so.”

Of more concern is underlying inflation, which is 0.5% above the European Central Bank’s 2% target level.

“Underlying inflation pressure in Germany is therefore higher than elsewhere. Austria is similar in that respect. It likely has something to do with the last big shock, which drove up - albeit with a delay - the growth rate of wages and price dynamics in the services industries in coordination, so that we are once again in a higher inflationary environment.” (See MNI: Further EU Measures Depend On Crisis Duration - Officials)

Germany's leading economic institutes this month cut their joint growth forecast to 0.6% in 2026 and 0.9% in 2027 - falls of 0.6 percentage points and 0.4 percentage points, respectively. 

Felbermayr said the hit to medium-term GDP growth from the crisis depends on the speed at which oil and gas prices return to pre-Iran war levels, during a period of “radical uncertainty.”

“My sentiment - and it is only that - is that markets are probably too optimistic. At the same time, if we get a resolution to the Russia problem and Russian oil is allowed to reach world markets again - of which there is maybe a 20% probability - uncertainty would be reduced. We also don’t talk enough about Venezuela, even though it will take time for Venezuelan oil to reach the market.” (See MNI INTERVIEW: Bar To ECB Hike Low, But Data Lacking-Pelagidis)

SOME OPTIMISM

But Felbermayr said he was optimistic that U.S. tariffs will remain at 10%, adding that while President Donald Trump may use the period ahead of July mid-term elections to “bash China, Europe, and foreigners generally, as is his tradition, higher tariffs won’t materialise, which will also help reduce inflationary pressure in the United States.”

A recent study by Germany’s ifo found that around 95% of additional government spending intended to boost capital stock is instead being used to meet day-to-day demands. The GCEE puts the figure at a still “terrible" two-thirds to three-quarters, Felbermayr said, calling policy action.

“[The government] need also to show that public infrastructure, including the transformation of the military, is actually happening, rather than just allowing firms such as Rheinmetal to absorb higher prices.”

While the governing coalition, acutely aware of the political threat from the far right, will be reluctant to impose any economic pain, Felbermayr, said it might still act. 

“It may be that budget constraints could help push the government into further structural reforms, including to the tax system, and the most recent speech by Finance Minister Klingbeil was really very interesting in that respect,” he said.

“These windows for reform are opening up now - as they have to be if we want to retain our prosperity. For that reason I think we can be slightly more optimistic than previously, in part because of this new crisis.”