Germany's Employment Connundrum

German unemployment has again fallen this month, and quite significantly:

The Federal Labour Agency said the number of jobseekers was down by a seasonally adjusted 45,000 last month, against economists’ expectations of a 30,000 fall, putting the jobless rate at 9 per cent. Internationally comparable figures calculated by the German statistical office using the more restrictive International Labour Office definition put the rate at 6.3 per cent in May. The new data brought the total fall in unemployment over the past 12 months to 671,000 and well over 1m since the start of the labour market recovery about two years ago. Employment showed an equally healthy picture, with 41,000 jobs created last month.

This is evidently very good news, but how do we interpret this data? Well with some caution I would argue. This is not, however, the normal response. Bertrand Benoit in the FT article linked to above is not atypical in this sense.

Benoit is almost gleeful:

The rapid fall in unemployment, long the most visible symptom of the “German disease”, has also proven wrong the doomsayers who said the country faced a future of growth without job creation.

He does, however, qualify this statement by pointing to Germany's evident structural dependence on exports:

Yet separate releases on Tuesday underscored what economists see as Germany’s vulnerable spot: its dependence on foreign markets.

Retail sales were up just 0.7 per cent in June against expectations of a 1.2 per cent rise. That followed a 2.5 per cent drop in May. Sales in the first half of the year were weaker than in the same period last year.
(See my post on this yesterday.)

As Benoit notes the "dichotomy between anaemic consumption and vigorous exports could spell trouble later this year as German exporters felt the impact from slowing demand in the US and the euro’s rising exchange rate" however, he then goes on to approvingly quote Gilles Moec, a senior economist at Bank of ­America, who says:

“We could see some wobbling in the second half, although we are confident about the six-to-nine-month horizon as we expect consumption to grab the baton from exports in supporting growth.”

So the real issue here is whether we might see anything more than "wobbling" here, and whether there are any reasons to question whether domestic consumption will in find resurrect itself and finally "take up the baton".

Well, in order to try and clarify what exactly is happening, and given a handy pointer by the Economist (who had a fairly useful article on the German labour market here), I went over to the Bundesbank, and started to consult their monthly reports.

What I found in the May 2007 edition was the following:


The situation in the labour market continued to improve at a rapid pace during the first few months of 2007 in the wake of the cyclical upturn. Employment rose once again, and unemployment showed a marked fall. The mild weather conditions also played a part in this favourable development. The number of persons in employment in the first quarter of 2007 rose by a total of 175,000, or 0.4%, to a seasonally adjusted 39.45 million. The year-on-year increase went up to around 570,000, or 1.5%, primarily in the form of employment subject to social security contributions. In particular, enterprises in the labour leasing sector, which accounted for just under half of the growth, stepped up their recruitment of new employees. Preliminary estimates by the Federal Employment Agency indicate that other forms of employment, such as low-paid part-time employment (mini jobs), activities in connection with job creation measures and employment opportunities (one-euro jobs) as well as assisted selfemployment have become less significant. Data on short-time working are not yet available for the first quarter. This form of employment is, however, likely to have increased again somewhat temporarily owing to the introduction of seasonal short-time working benefits in the construction sector. This is suggested in any event by the data for December 2006, according to which almost 30,000 more persons were receiving benefits than in November.

There was a further perceptible decline in the official unemployment figure in the first quarter. At a seasonally adjusted 3.91 million, there were 287,000 fewer persons registered as unemployed than in the final quarter of 2006. The year-on-year decline widened to 820,000 persons. At 9.4%, the seasonally adjusted unemployment rate was 0.6 percentage point down on the quarter. Within the space of a year, the unemployment rate had gone down by a substantial 2.1 percentage points.


However, the decline in unemployment in the first quarter of 2007 is likely to have overstated the cyclical influence and the mediumterm trend somewhat. Both the favourable weather conditions and the introduction of seasonal short-time working benefits are likely to have had a certain mitigating effect. The pick-up in the labour market in the second quarter could therefore be somewhat weaker than usual. At all events, there was barely any further decline in seasonally adjusted unemployment in April and the unemployment rate remained virtually unchanged on the month at 9.2%. It is also important to remember that, for demographic reasons, the labour supply is currently decreasing, which means that the fall in unemployment appears to be greater than the increase in employment. This is also due in part to the fact that the Federal Employment Agency is continuing to adjust the unemployment statistics.


Wages


The 2007 pay round began in March with wage agreements in the chemical and construction industries. The metal-working and electrical engineering industries followed in May. Firstly, the negotiating partners in the chemical industry agreed on an increase in basic salaries of 3.6% starting from the second month of the term of the agreement, which runs for a period of 14 months. A flat-rate payment of 370 will be made in the first month, and a supplementary 0.7% of a month’s salary for each of the remaining months of the contract. In the construction industry, the negotiating partners agreed on a 12-month pay settlement with no increase in the first month followed by a 3.1% increase in the standard monthly remuneration. Additionally, monthly one-off payments of 0.4% of a single month’s salary are to be made. Owing to the objections of some regional employers’ federations to the outcome of the negotiations, however, a conciliation process has now been initiated. Moreover, the pay agreement in the construction sector, which has not yet been accepted, does not affect the existing minimum wage agreement, which is still valid until the end of August 2008 and which provides for an increase in wages and salaries of 1% as of 1 July 2007. The special payments negotiated in the chemical and construction industries can be modified or completely cancelled at individual firm level by alternative agreements. Pay in the metal-working and electrical engineering industries is to be increased by 4.1% as of June 2007. This is to be followed by a further increase of 1.7% in June 2008. A one-off payment of 3400 has been agreed for the first two months of the wage agreement, and one-off payments of 0.7% of a month’s salary for the final five months. The scheduled increases and special payments from June 2008 may be deferred by up to four months at the individual firm level. The wage agreements in the major industrial sectors are a reflection of the cyclical improvement in the trade union’s bargaining position resulting from above-average capacity utilisation and ample reserves of orders. It is also a question of giving employees a fair share of the reward for the enterprises’ economic success, which has become possible not least owing to the wage restraint of the past few years. Pay agreements in the craft trades were much more moderate than in industry. A negotiated wage increase of 2.5% was agreed in the motor vehicle trade of the Federal State of North-Rhine Westphalia as well as a one-off payment of 350 for the first month of the 12-month wage agreement. In the electrician’s trade, agreement on a 2.4% wage increase was also reached in North- Rhine Westphalia (effective as of 1 February 2007) after 34 months without a pay rise.

Wages are to be increased by a further 2.2% one year later. Similar agreements were also reached in other wage-bargaining areas. According to the Deutsche Bundesbank’s pay rate statistics, negotiated rates of pay in the first quarter of 2007 were 0.8% up on the year, compared with +1.8% in the final quarter of 2006. The latter figure was primarily attributable to the one-off flat-rate payment for Volkswagen employees to compensate for the increase in weekly working hours. Furthermore, there were one-off payments in the chemical industry and in the metal working industry in the first quarter of 2006, which were not repeated on this scale. Excluding one-off payments, negotiated rates of pay went up by 1.2% in the first quarter of the 2007, compared with 1.6% in the final quarter of 2006, when public sector banks paid a Christmas bonus which compensated for the lack of holiday pay.


Construction Costs


Following the continuous rise in the cost of construction services over the past few years, prices went up by no less than 4.3% in the first quarter of 2007, and the year-on-year rate of increase widened to 7.7%. There were price rises on this scale in virtually all subsectors of construction. This surge in construction prices is attributable to the VAT increase on 1 January 2007 and the sharply increased prices of intermediate goods. Added to this was an exceptionally high level of utilisation of machinery and equipment. Construction industry capacity has been run down in recent years, which means that the increasing recovery in demand for construction work is now encountering a scarcer supply. Furthermore, labour cost pressure, which has been moderate up to now, is likely to intensify somewhat against the backdrop of the recent wage agreement. A rise in construction prices, especially in residential construction, is usually also reflected – with a certain time lag – in the prices of older buildings and housing rents. Nevertheless, the fact that land prices are virtually unchanged is continuing to have a dampening effect.

Consumer Prices: VAT perciptible effect


In the first three months of this year, the rise in consumer prices, at a seasonally adjusted 0.6%, was distinctly sharper than in the preceding months. The year-on-year increase in the national consumer price index (CPI) went up from 1.3% in the fourth quarter of 2006 to 1.7% in the first quarter of 2007. This corresponding figure for the Harmonised Index of Consumer Prices (HICP) was 1.9%, compared with 1.3% at the end of 2006.



One reason for the sharp rise in prices, despite the fact that crude oil cost less on average, was that consumer energy prices rose by 2.3% on the quarter and 2.4% on the year. This was due chiefly to the increase in the standard rate of VAT from 16% to 19%, which took effect on 1 January 2007. The higher level of VAT also had a clear impact on the other components (for more information, see the initial results of a macro data analysis on pages 52-53). The cost of industrial goods (excluding energy and tobacco products) increased by a seasonally adjusted 0.5% in the first quarter of 2007, and the year-on-year figure went up from 0.6% to 1.4%. The effect of VAT on prices in the first quarter of 2007 was particularly marked in the case of motor vehicles; the year-on-year rate of price increase widened from 1.1% to 3.0%. There was an interruption in the downward price trend for household appliances. The cost of services (excluding housing rents) increased by a seasonally adjusted 0.8% on the quarter. The corresponding year-on-year rate doubled to 2%, a part in this also being played by the increase in insurance tax from 16% to 19%. As a consequence, insurance premiums were up by an average of 2.6% on the year. Significant VAT effects were apparent in the prices of hairdressing and motor vehicle repairs, for example.

In assessing the overall impact of the VAT increase, there arises the problem that price adjustments are made for other reasons as well at the same time. Therefore, the “normal” price rise excluding VAT has to be deducted from the overall price increase. In the case of the two subcomponents of goods (excluding energy and tobacco) and services (excluding housing rents), it may largely be assumed that the price trend excluding VAT would have been much the same as in the previous two years. In the absence of more detailed information, it would appear reasonable to assume that, in the case of energy, the VAT increase was passed on in full. According to this calculation, the higher rate of VAT contributed around 0.6 percentage point to the quarter-on-quarter rate of increase in the national consumer price index (CPI) and just under 0.8 percentage point to the HICP increase. 2 This increase came on top of advance price adjustments last year, such as the increase in tobacco prices of just under 5% in October. There were also indications of accelerated price adjustments in the case of other goods, such as cosmetics and clothing. If these anticipatory effects are added to the price effects in the first quarter of 2007, the overall contribution of the higher rate of VAT to the year-on-year CPI increase is roughly 1 percentage point.3 The figure is likely to be somewhat higher for the HICP. The price effect of the VAT increase was thus considerable, but smaller than the mathematical effect of a direct full pass-through of 1.4 percentage points to the CPI and 1.6 percentage points to the HICP. Two factors need to be taken into consideration in this context. One is that a reduction in social security contributions in January 2007 provided relief to enterprises. The other is that it may be assumed that there will be further lagged VAT-induced price adjustments in the course of 2007.

German Retail Sales and the VAT Hike

German retail sales rose (slightly) in June over May 2007, but what a song and dance Bloomberg make about this:


"Retail sales in Germany, Europe's largest economy, rose in June as the effect of an increase in sales tax at the start of the year waned. Sales, adjusted for inflation and seasonal swings, rose 0.7 percent from May, when they declined 2.5 percent, the Federal Statistics Office in Wiesbaden said today.......Germany may be able to rely more on domestic demand to drive economic expansion as the impact lessens of the Jan. 1 increase in value-added tax, a levy on sales."

Now, none of this is at all apparent, neither the rise in sales, nor the ability to rely on domestic demand (as I argue here). So lets see what the German Statistical Office actually say:


Turnover in retail trade in June 2007: – 0.8% in real terms on June 2006

WIESBADEN – According to provisional results of the Federal Statistical Office, turnover in retail trade in Germany in June 2007 was in nominal terms 0.2% and in real terms 0.8% smaller than that of the corresponding month of the previous year. The number of days open for sale was 26 in June 2007 and 25 in June 2006.

When adjusted for calendar and seasonal variations (CENSUS-X-12-ARIMA), the June turnover was in nominal terms 0.6% and in real terms 0.7% larger than that of the preceding month.

Compared with the corresponding period of the previous year, retail turnover was in the first six months 2007 in nominal terms 0.8% and in real terms 1.5% smaller than that in the first six months of 2006.

Now, look at the headline. That's right, retail sales year on year were actually 0.8% down in June 2007 over June 2006. So we can all see what is going on I have prepared a small chart which shows the retail sales time series from January 2006.



As we can see, retail sales seem to have had a small spike in April 2007, and apart from that they are down in the first half of 2007 over the 2006 level (0.8% over six months). The German economy is by all accounts having a big export lead boom, so what is happening to retail sales. And what was that Bloomberg was saying about a demand driven recovery?

Quick Check-up on the Eurozone

by Claus Vistesen

Cross posted from Alpha Sources

As the header suggests this is small update on the recent news we have out on the Eurozone. First of all we have the industrial orders which showed a rebound in May and although this constitutes somewhat of a backward looking glance at this point. However, the fact that industrial orders are not on a secular decline shows that capex might keep momentum longer than expected. All big member countries saw respectable growth both on a monthly and a yearly basis. Also in France did we get some welcome news from a key domestic indicator as household consumption rose in June after a slump in May ...

French consumer spending on manufactured goods grew more than twice as much as expected in June as unemployment fell in Europe's third-largest economy.

Such spending, which accounts for about 15 percent of the economy, jumped 1.6 percent from May, when it fell a revised 1 percent, Insee, the Paris-based national statistics office, said today. It was the biggest gain since August and beat the 0.7 median forecast of 30 economists in a Bloomberg News survey.

Household spending is rebounding after France's jobless rate fell in May to 8.1 percent, the lowest since June 1982, and as new President Nicolas Sarkozy pledges to boost the economy by loosening firing rules and cutting taxes by 13 billion euros ($18 billion).

However, this also marks the end of the good news on the Eurozone and in Italy consumer confidence stayed at a one year low in June which does not at all bode well for Q2 - Q4 GDP.

Italian consumer confidence remained near a 14-month low in July, as rising interest rates and higher gasoline costs left families with less money to spend.

The Rome-based Isae Institute's index, based on a poll of 2,000 households, rose to 107.4 from 107.2, which was the lowest since May of last year. The July reading was less than the median forecast of 108 by 20 economists surveyed by Bloomberg News.

``Interest rates, a strong euro and oil prices have all been overlooked a bit given the strong demand we've had in the past, so they may be finally starting to weigh on spending,'' said Ilaria Spinelli, an economist at Fideuram Investimenti Sgr in Milan.

Italians have seen their disposable income shrink after the highest interest rates in six years and a jump in energy costs erode what consumers have to spend. Gasoline prices in Italy have increased more than 12 percent this year and that gain is weighing on confidence as the summer driving season begins.

And finally we have the latest aggregate data on manufacturing and services which furthermore posted a decline in July. The decline was no means dramatic but it does suggest as I have been previously arguing here that the latter part of 2007 might look somewhat differently from the former.

Growth in Europe's manufacturing and service industries, which account for two thirds of the economy, slowed more than economists expected in July as the euro rose to a record and oil prices increased.

Royal Bank of Scotland Group Plc's combined index, spanning industries from autos to banking and airlines, fell to 57.3 from 57.8 in June, Reuters Plc reported. Economists expected the composite index to slip to 57.6, according to a Bloomberg News survey. A reading above 50 indicates expansion.

The euro's surge to a record against the dollar and the yen is eroding the competitiveness of European exports, the mainstay of economic growth over the past two years. Rising oil prices may also sap domestic spending and cool an economy that last year grew at the fastest pace since 2000.

Whether all this will trickle through to Frankfurt remains to be seen but at this point it seems as if inflation is still the biggest bogey man for the ECB. In FX land, the US subprime woes weighed heavier on the EUR/USD than the mildly negative data stream from Europe although the Dollar paired the decline during the day.

Update on Friday, July 27, 2007 at 10:32PM

Well, since I wrote this there have been some other indicators out on the Eurozone which deserves mention. The general picture conform with the view that growth might now be slowing somewhat in the Eurozone although the news was not entirely on the downside.

First off in France, business confidence stayed at its high level from last month ...

French business confidence remained near a six-year high in July as falling unemployment spurred consumer spending, suggesting growth is accelerating in the second half.

Insee, the Paris-based national statistics office, said today its index of sentiment among 4,000 manufacturers was unchanged at 110 in June. The confidence measure held at its second-highest level since the first quarter of 2001 after reaching 112 in April, and was in line with the median forecast of 29 economists in a Bloomberg survey.

In Germany on the other hand business confidence declined for a second consecutive month ...

German business confidence fell for a second month in July as the euro's gains and rising oil prices threaten to curb growth in Europe's largest economy.

The Munich-based Ifo research institute said its sentiment index, based on responses from 7,000 executives, fell to 106.4 from 107 in June. That's in line with economists' median estimate in a Bloomberg News survey. The index has averaged 96 since records for a reunified Germany began in 1991. It reached a record of 108.7 in December.

However, consumer confidence stayed upbeat in Germany although consumers are growing somewhat anxious on a relative basis regarding income expectations. Yet, the ever improving labour market is still the main driver of sentiment it seems.

Consumer confidence in Germany, Europe's largest economy, rose to an eight-month high after unemployment declined to the lowest level in 12 years.

GfK AG's confidence index for August, based on a survey of about 2,000 people, rose to 8.7 from 8.5 in July, the Nuremberg- based market-research company said today. Economists expected a gain to 8.8, according to the median of 25 forecasts in a Bloomberg News survey. The July reading was revised up from 8.4.

German households are growing more optimistic as companies increase capacity and hire more workers to meet orders. Still, business and investor confidence fell in July, suggesting economic growth is slowing from the fastest pace since 2000.