The tide

Disinflation is steelier than German metalworkers

German metalworkers and their employers are on one side of the greatest fight in the financial world. Economic realities, demographics, and investors around the world are lined up on the other side. The fight is over the direction of interest rates.

A relatively generous 3.4 per cent wage increase for metalworkers in one German region, announced earlier this week, has no direct effect on policy rates, but there is an indirect path. Imagine that all the employees in Europe's largest economy were awarded similar hikes.

Employers would eventually have to raise prices. This would reverse the trend in German consumer prices, which have fallen by 1.5 per cent since September 2014. That, in turn, would create room for wage and price increases in Germany's trading partners. In response, investors would gradually demand higher interest rates and the European Central Bank would deliver them.

Something like this could happen, but there are many obstacles. Wage contagion is doubtful. German metalworkers' position is unusually strong, as is the German economy. The fall in the oil price, which helped drive US consumer prices down by 0.7 per cent in February, sets a disinflationary tone to future wage negotiations. Social conscience moves, such as giant retailer Wal-Mart's announced wage increases at the bottom of the pay scale, are unlikely to compensate.

Meanwhile, central banks' monetary policy remains generous, so policy rates will lag prices. Investors, who could balk at ultra-low yields, aren't protesting. Germany just issued a five-year government bond yielding -0.08 per cent.

More fundamentally, it's hard to revive inflation when relatively young people who expect steady pay rises make up a declining proportion of the workforce. This structural demographic negative weighs heavily on labour markets in all developed countries. It is increasingly an issue in China.

If the authorities, political as well as monetary, want to reverse the three-decade old disinflationary trend, wages are probably the best place to try. But while the German Bundesbank and the Japanese prime minister have pleaded for a lack of pay restraint, few seem to be listening.