Trichet Focuses on Inflation as Lufthansa Lifts Wages

By Simon Kennedy and Bernd Bergmann
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Aug. 7 (Bloomberg) -- Robert Revet, a flight manager for Deutsche Lufthansa AG, just won a 5.1 percent raise from the German airline after spending last week out on strike.

``With a bit of luck, this pay increase will help us keep up with inflation, at least for a while,'' Revet, 56, said as he returned to work at Frankfurt airport on Aug. 1. ``With inflation where it is, we wanted a significantly better deal this time.''

Revet's satisfaction won't be shared by European Central Bank President Jean-Claude Trichet, who economists predict will leave the benchmark interest rate at 4.25 percent today. Pay deals like the one at Lufthansa may force him to keep rates at a seven-year high for longer or even tighten again to contain inflation, raising the risk of a deeper economic slump in the 15-nation euro region.

``This is an inflation-busting wage raise that will worry the ECB,'' said David Owen, chief economist at Dresdner Kleinwort in London, who expects the central bank to lift rates next month. ``Trichet will stay on alert in warning about wage inflation.''

Policy makers say they're concerned a wage-price spiral will develop as the higher cost of living prompts workers to seek more pay and companies raise prices to compensate.

Record oil and food costs pushed euro-region inflation to 4.1 percent in July, the fastest in more than 16 years and double the ECB's 2 percent limit.

Economic Slump

At the same time, the economy is faltering. Societe Generale SA economists estimate gross domestic product shrank 0.5 percent in the second quarter from the first. By contrast, the U.S. economy expanded 0.5 percent in the three months through June.

The Frankfurt-based ECB, which increased borrowing costs last month, publishes today's decision at 1:45 p.m. and Trichet holds a press conference 45 minutes later. Separately, the Bank of England will leave its key rate at 5 percent, another survey of economists shows. That decision is due at noon in London.

Lufthansa employees aren't alone in securing inflationary pay deals in Germany, Europe's largest economy. Negotiated wages jumped 3.5 percent in the year through April, the biggest gain in 12 years, as companies such as BASF AG and ThyssenKrupp AG bowed to union demands.

This year's wage rounds culminate next month, when IG Metall, Germany's biggest union, starts talks for 3.2 million metal, electronics and car workers whose collective contracts expire Oct. 31. The union won a 5.2 percent raise for about 85,000 steelworkers in February.

`Room for Maneuver'

Pay packets are also growing in economies which, unlike Germany, haven't spent recent years containing labor costs and boosting productivity. Wage inflation in Italy accelerated to 3.6 percent in June, the fastest in three years.

In a bid to restrain inflation expectations and persuade workers that the current price shock will pass, the ECB lifted its benchmark rate by a quarter point on July 3. The U.S. Federal Reserve this week left its key rate at 2 percent.

ECB council member Klaus Liebscher signaled there may be a need for still higher borrowing costs in Europe, saying in a July 24 interview that ``we haven't exhausted our room for maneuver'' even as economic growth slows.

Adding to the ECB's concerns is the fact that seven European countries index wages to inflation, a policy Trichet has labeled ``extremely dangerous.'' In Belgium, Cyprus and Luxembourg, wages are automatically adjusted for past consumer-price increases, while Spain, France, Malta and Slovenia also have some form of indexation, according to the ECB.

`Dominant Worry'

``The ECB will continue to see a worrying trend in wage growth,'' said Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland Group Plc in London. ``This is likely to remain the central bank's dominant worry and will probably push it to raise rates again despite signs that downside risks to the economy are materializing.''

Europeans' confidence in the outlook for the economy dropped the most since the Sept. 11 terrorist attacks last month and unemployment rose for the first time in three years in May, reports showed last week. Barclays Capital estimates the economy contracted in the second quarter and will stagnate in the third after growing 0.7 percent in the first three months of the year.

The European Union's statistics office will release second- quarter GDP figures on Aug. 14.

Slowing growth will ``probably prevent firms from passing much of these wage increases on to consumers,'' said Holger Schmieding, chief economist at Bank of America Corp., who still expects the ECB to keep rates unchanged for a year. ``Wages are a concern for the ECB, but will be outweighed by rising recession risks.''

50-50 Chance

Ken Wattret, an economist at BNP Paribas SA in London, said there's a 50-50 chance the ECB will increase rates again, although its room to do so will narrow as the economy splutters. ``How wage developments evolve will be crucial to the evolution of monetary policy,'' said Wattret.

That means the likes of Lufthansa's Revet may ultimately decide the direction of interest rates.

``If the workers keep demanding higher wages, the ECB has no choice but to raise rates,'' said Michael Schubert, an economist at Commerzbank AG in Frankfurt. ``The ECB doesn't want to be blamed for cooling the economy, but it will do so to beat inflation.''

To contact the reporters on this story: Simon Kennedy in Paris at Skennedy4@bloomberg.net; Bernd Bergmann in Frankfurt on bbergmann1@bloomberg.net.