Summary
- Stronger margins, not wages fueling inflation, data shows
- ECB policymakers discuss issue at Arctic retreat – sources
- Data may help case against more rate hikes – analysts
Huddled in a retreat in a remote Arctic village, European Central Bank policymakers came to grips recently with some cold facts: firms are profiting from high inflation while consumers and workers foot the bill.
The widespread macroeconomic narrative over the past nine months has been that steep increases in prices for everything from food to energy to computer chips were pushing up costs for companies in the 20 countries that form the eurozone.
The European Central Bank (ECB) responded by hiking interest rates by the most in forty years to quell demand, asserting it faced the risk that higher consumer prices would boost wages and create an inflation spiral.
But at the retreat in the Finnish village of Inari aimed at giving the bank’s Governing Council a chance to look into themes only touched upon at regular meetings, a slightly different picture unfolded, three sources who were present at the meeting said.
Data articulated in more than two dozen slides submitted to the 26 policymakers indicated that company profit margins have been growing rather than shrinking, as might be expected when input costs increase so steeply, the sources told Reuters.
An ECB spokesperson would not comment for this story.
“It’s clear that profit expansion has played a larger role in the European inflation story in the last six months or so,” said Paul Donovan, chief economist at UBS Global Wealth Management. “The ECB has failed to justify what it’s doing in the context of a more profit-focused inflation story.”
The idea that firms have been hiking prices in excess of their costs to the detriment of consumers and wage earners is expected to anger the public.
But it has repercussions for central bankers too.
Inflation stoked by higher corporate margins tends to self-correct as firms eventually rein in price hikes to avoid shedding market share, making it a very different beast to restrain than a wage-price stampede.
So a new inflation narrative centred on margins could provide the more dovish members of the Governing Council some ammunition to combat further rate hikes after their resistance proved mostly futile over the past year, according to economists queried by Reuters.
The debate is expected to resume at the ECB’s upcoming policy meeting on March 16, when the bank has vowed to hike rates to their highest level since the height of the financial crisis in 2008.
Change In Narrative
The prevailing inflation narrative in the eurozone has been gradually starting to shift. Businesses are predicting smaller price hikes as the outlook for costs and demand becomes darker, according to surveys published by the ECB and Germany’s Ifo institute.
Some European nations such as Greece have tabled measures to combat inflation in essential goods while Spain and France are discussing similar steps.
“The economics of profitability suggest we might see more of a profit squeeze coming up,” ECB chief economist Philip Lane told Reuters. “European firms know that if they raise prices too much, they will suffer a loss in market share.”
In the United States, the profit margin growth began earlier and has already begun to reverse, albeit slowly and unevenly.
However, unlike the United States, there is no official corporate margin data for the eurozone. Rather, national accounts and earnings reports from listed firms are being used as proxies to draw the inflation picture.
Eurozone consumer goods firms, for instance, increased operating margins to an average of 10.7% in 2022, a rise by a quarter over 2019, before the global pandemic and the conflict in Ukraine, Refinitiv data shows.
The 106 firms included in the survey ranged from carmaker Stellantis (STLAM.MI) to French resort owner Pierre et Vacances (PVAC.PA) to Nordic retailer Stockmann (STOCKA.HE) and luxury goods group Hermes (HRMS.PA).
Similarly, profits rather than taxes and labour costs have formed the largest share of domestic price pressures in the eurozone since 2021, according to ECB calculations based on Eurostat data.
Detached Discourse
Indeed, wages have been increasing much more slowly than inflation, hinting at a 5% fall in the standard of living for the average employee in the eurozone compared with 2021, ECB’s calculations showed.
The opposite of the wage-led inflation that dominated the 1970s, an era that has become the most broadly used point of comparison in the public debate about suitable central bank policy responses, economists say.
“The public discourse to some extent is detached from what’s actually happening out there,” said Philipp Heimberger, an economist at the Vienna Institute for International Economic Studies.
“The main story of the risks going forward is still that there’s a looming wage-price spiral which should make the central bank even more aggressive in hiking interest rates.”
For instance, wages were cited 14 times in ECB President Christine Lagarde’s latest news conference while margins didn’t get even one mention. Her deputy, Luis de Guindos, also cautioned that the ECB needed to be cautious because labour unions might ask for excessive pay hikes.
“You see a very clear reluctance to discuss profit,” Daniela Gabor, a professor of economics and macro-finance at the University of West England in Bristol. “That illustrates that the distributional politics of inflation targeting is: You don’t go for profits; you don’t go for capital.”
In the United States, the issue of runaway margins has been voiced by former Federal Reserve Bank vice-chair Lael Brainard, who is currently President Joe Biden’s top economic adviser, and Democratic senators Bernie Sanders and Elizabeth Warren.
An analysis by @EconomicPolicy found that the spike in profit margins since the pandemic explains roughly 40% of the rise in prices since mid-2020. Meaning? While Americans were struggling with high costs, giant corporations were padding their bottom line. Outrageous.
— Elizabeth Warren (@SenWarren) February 19, 2023
Corporate profits have never been higher. And what about working people? They continue to struggle. Not acceptable. pic.twitter.com/Es6qlRb9cm
— Bernie Sanders (@BernieSanders) October 27, 2022
Even inside the ECB, labour representatives asking for higher pay for central bank employees have distanced themselves from what they call the institution’s “anti-worker bias”.
They cited, among others, a paper by researchers at the International Monetary Fund indicating that increasing wages have not historically triggered a wage-price spiral.
Profit VS Wages
ECB policymakers convened in Finland looked through similar data sets indicating that profits had outperformed wages because of savings built up during lockdowns being spent, but also thanks to firms’ power to set prices, the sources said.
With those savings now being used up and competition resuming, things may be changing for ECB policymakers who have been asking for a redrafting of the inflation narrative.
In January, Portuguese central bank governor Mario Centeno was among the first to issue a warning about the risk of a very clear growth in profit margins, saying it should be touched on in the European policy agenda.
ECB board member Fabio Panetta later said employees had borne the brunt of the hike in prices while, on balance, company mark-ups had stayed stable, or even grown in some sectors.
Wages are increasing, with the ECB’s forward-looking wage tracker predicting a hike of almost 5% in 2023 for contracts signed in the final quarter of last year. But that won’t cancel the massive fall in real wages over the past year, analysts said.
Buy Bitcoin Now“A key missing ingredient is the bargaining strength of the labour movement, which is structurally weakened by the disinflation policies of the 1980s and the ensuing liberalization of labour markets,” said Mattias Vermeiren, a professor of international political economy at the Ghent Institute for International and European Studies.
During the previous inflation crisis in the 1970s, almost 70% of economic output was awarded to employees, with only over 20% assigned to profits, according to Eurostat data. Now, labour’s share stands at 56 percent with a third going to profits.
The ECB policymakers weighed up those differences at their Finnish retreat, though their tentative conclusions were dotted with caution, the sources who were present at the meeting said.
Some assert that furlough schemes during the pandemic may buoy up incomes, the sources said, and that a prolonged period of high inflation may increase salary demands in a way that models created during periods of stable prices fail to predict.
The interest rate doves might have their work cut out after data showed inflation in Spain, France, and Germany surpassed expectations in February.
