German unemployment fell to a six-year low last month, more than double the fall economists had predicted, underlying the strength of Europe's largest economy ahead of what could be a challenging year.

In its monthly report, published yesterday, the Federal Labour Agency said seasonally-adjusted unemployment had dropped by 78,000 to 3.4m, almost twice the average monthly fall in the past year. Altogether, more than half-a-million people came off jobless benefits in the past year.

The internationally comparable jobless rate, which lags one month behind the national data, stood at 7.9 per cent in November - the lowest level since the end of 2001 - thanks to robust economic growth, an increase in hiring, and a fall in the number of people claiming unemployment benefits.

This is a positive report," said Elga Bartsch, Europe economist at Morgan Stanley. "Labour market statistics are a lagging indicator, but at the very least they tell us Germany is well equipped to face the challenges of this year."

More surprising to economists than the Labour Agency's figures were a series of business sentiment survey showing resilient hiring intentions among managers. These suggest the improvement of the labour market, now in its 21st month, should continue in the coming month.

The Ifo institute's employment barometer, to be published on Friday, will stand at 106.8 points in December, according to a copy obtained by the Financial Times - markedly above the average of the past 12 months.

The data is the latest evidence that the German economy has proven resilient despite strong economic headwinds, defying the global financial market turbulences and credit squeeze, the sharp rise in the euro, rising raw materials and energy prices, and the marked US slowdown.

Economists believe German manufacturers - the country was again crowned the world's largest exporter of goods by the World Trade Organisation in 2007 - will eat into their profit margins this year rather than concede market share due to the stronger euro.

Likewise, German companies' low reliance on debt to finance investments - about 90 per cent of investment spending is financed by earnings against 60 per cent in France - and stable level of household debt mean the country should keep brushing off the effect of the credit squeeze.

A more serious cause for concern is the gradual introduction of minimum wages in specific sectors, which began late last year and should continue this year, and the generally higher wage settlements amid mounting trade union activism.

Analysts believe chancellor Angela Merkel's Christian Democratic Union, which has so far opposed the introduction of a universal minimum wage, could even buckle this year in the face of overwhelming popular support for the measure, including among party members.

"This will open a can of worms nobody will ever be able to shut again," Ms Bartsch said, calling the introduction of sectoral minimum wages the "end of political innocence in German labour relations." This, she fears, will destroy the tacit contract whereby the state does not interfere in wage setting while trade unions refrain from political strikes.

The worst possible outcome would be a reversal of the decline in unit labour costs that gave German companies a powerful competitive boost over the past five years. Given the political climate, with a government that is backtracking on the structural reforms of the past ahead of important regional elections, hefty wage rises will be all the more toxic for the economy because they will no longer be offset by reductions in non-wage labour costs, such as social security contributions, as of this year.

"That my forward-looking employment indicators have not started to weaken is actually a bit of a surprise," Ms Bartsch said. "I'm expecting this to happen anytime now."

Financial Times, Jan. 03, 2008