I've just returned from Germany, visiting the great in government, bureaucracy, Bundesbank and the European Monetary Institute. I'm convinced the Bundesbank will raise interest rates by 25 basis points before the year-end and by around 200bp by the end of 1998.
The German economy is now recovering, as export-led growth is starting to spill over into domestic demand. Capacity utilization is higher than in the US. Companies are making huge profits, which have grown dramatically as a share of national income because unit labour costs have dropped as corporations rationalize. So capital investment is taking off. A lot of it is offshore, but that still results in rising demand for capital goods. Once recovery is confirmed, the Bundesbank will switch to a more neutral monetary policy.
Unemployment has topped out in western Germany. Wage demands may grow from here. So the contribution of low unit labour costs to low inflation will probably peter out over the next year. CPI inflation is at the Bundesbank's upper threshold and will get worse. Sure, administered prices have caused a lot of it. But PPI inflation is up too. That's due to import price inflation. The Bundesbank, for this reason, doesn't want a weaker Deutschmark.