Germany: Wage pass-through close to the end?

S ince 2022 German wages have significantly contributed to inflation dynamics, which possibly explain that companies have partially absorbed these cost increases by compressing their margins, reaching now at a low point. T h e slowdown in actual earnings seen in Q1 could be reflected in the evolution of inflation , notably in the service component . In this report, we conduct an in-depth analysis of the price-wage transmission mechanisms to determine to what extent this slowdown could contribute to the normalization in core inflation . With an expected subdued production in 2025 , margin improvement will need to come from cost reductions, particularly in the industr ial sector . This situation is likely to lead to a weakening of the wage bargaining power , and thereby, it is likely to accentuate the deceleration in wage growth, as unions will prefer to focus on securing jobs in the spirit of the past Hartz reforms . The increase in the statutory minimum wage from €12.82 to €15 by 2026 questions a possible new price-wage loop. Between the pass-through of wage increases to prices and the adjustment of labor demand, we believe that companies will opt for the latter option , e specially for industrial companies which have less pricing power than services companies . W e expect actual earnings to decrease from 6 % in 2024 to 1.5 % in 2025 before rising again in 2026 at 5% . Consequently, core inflation should decrease from 3.2% in 2024 to 2.8% in 2025 and 2.6% in 2026, while services inflation would decrease from 3.9% in 202 5 to 3.1% in 2026 . T aking into account this future evolution, the slow normalization of German core inflation and the development of services inflation might, all else being equal, encourage the ECB to adopt a slower and more cautious approach to policy rate normalization.