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Investing.com -- Germany’s upcoming fiscal stimulus is expected to have only a modest effect on inflation, according to Capital Economics.
Despite the government’s budget deficit forecast to widen from 2.8% of GDP in 2024 to around 4% in 2026 and 2027, the stimulus will likely push core inflation only slightly above 2% in the coming years.
Capital Economics notes that most of the additional spending is directed toward defense and infrastructure, areas that do not directly feed into the Harmonized Index of Consumer Prices (HICP), the key measure of consumer inflation. As a result, the direct impact on consumer prices will be minimal.
Although prices for materials like metals, used in both defense and consumer sectors, could increase, global market conditions largely determine these prices.
Additionally, Germany’s auto sector, a major consumer of metals, is in decline, which may offset some of the demand pressures.
Materials and services for home maintenance and repairs make up only 1.3% of the HICP basket.
The stimulus is also unlikely to significantly raise household disposable incomes. Most funds are expected to flow to firms producing investment goods rather than to households.
While military spending may benefit personnel, the Bundeswehr employs just 260,000 people, or 0.6% of the workforce, and recruitment difficulties limit expansion.
Planned tax cuts on overtime and pensioner employment are also expected to have a limited impact.
Wage growth may rise moderately, particularly in construction, which accounts for nearly 6% of total employment.
Labor shortages in the sector have persisted despite weak activity, suggesting potential for wage increases. However, three key factors are expected to temper any broader wage-driven inflation.
First, there is still spare capacity in the labor market. Unemployment has risen to 3.7%, up from a low of 3%, and labor shortages have declined in services and manufacturing.
The number of workers on short-time work schemes has also increased, especially in manufacturing.
Second, wage-setting mechanisms in Germany typically result in slow and limited wage adjustments.
Most wages are negotiated through multi-year collective agreements, and unions have shown restraint in recent years.
Recent wage hikes were primarily driven by efforts to recoup previous real income losses, not by rising labor demand.
Third, low headline inflation is expected to keep wage demands contained. Falling oil and gas prices, along with government plans to reduce electricity taxes and VAT on restaurant services, are expected to weigh on inflation. The Bundesbank has already observed that union wage demands have eased as inflation subsides.
Capital Economics projects core inflation in Germany will decline from 2.8% in 2025 to 2.3% in both 2026 and 2027. Headline inflation is forecast to fall to 2% in 2026 and 1.8% in 2027.
While the stimulus may offer some support to wage growth, the report concludes that its overall inflationary impact will be limited and remain consistent with the European Central Bank’s 2% target.