Insight: ECB confronts a cold reality: companies are cashing in on inflation

Lindex Oyj

02/03/2023 06:00

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      Higher margins not wages driving inflation, data shows
    

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      ECB policymakers debated issue at Arctic retreat - sources
    

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      Data may help case against more rate rises - analysts
    

  
    By Francesco Canepa
       FRANKFURT, March 2 (Reuters) - Huddled in a retreat in a
remote Arctic village, European Central Bank policymakers faced
up last week to some cold hard facts: companies are profiting
from high inflation while workers and consumers foot the bill.
    The prevailing macroeconomic narrative over the past nine
months has been that sharp increases in prices for everything
from energy to food to computer chips were ramping up costs for
companies in the 20 countries that make up the euro zone.
    The European Central Bank (ECB) responded by raising
interest rates by the most in four decades to cool demand,
arguing it faced the risk that higher consumer prices would push
up wages and create an inflation spiral.
    But at the retreat in the Finnish village of Inari intended
to give the bank's Governing Council a chance to delve into
themes only touched upon at regular meetings, a slightly
different picture emerged, three sources who attended the
meeting said.
    Data articulated in more than two dozen slides presented to
the 26 policymakers showed that company profit margins have been
increasing rather than shrinking, as might be expected when
input costs rise so sharply, the sources told Reuters.
        An ECB spokesperson declined to 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 companies have been raising prices in excess
of their costs at the expense of consumers and wage earners is
likely to anger the general public. 
    But it has implications for central bankers too. 
    Inflation fuelled by higher corporate margins tends to
self-correct as companies eventually put the brakes on price
rises to avoid losing market share, making it a very different
beast to tame than a wage-price stampede. 
    So a new inflation narrative focused on margins could give
the more dovish members of the Governing Council some ammunition
to fight against further rate rises after their resistance
proved largely futile over the past year, according to
economists interviewed by Reuters.
    The debate is due to resume at the ECB's next policy meeting
on March 16, when the bank has promised to raise rates to their
highest level since the height of the financial crisis in 2008.
    
    CHANGE IN NARRATIVE
    The received inflation narrative in the euro zone has been
slowly starting to shift. 
    Businesses are anticipating smaller price rises as the
outlook for costs and demand becomes less clear, according to
surveys published by the ECB and Germany's Ifo institute. 
    Some European countries such as Greece have tabled measures
to curb inflation in essential goods while France and Spain are
debating 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 expansion started
earlier and has already started to reverse, albeit slowly and
unevenly.
    But unlike the United States, there is no official corporate
margin data for the euro zone. Instead, national accounts and
earnings reports from listed companies are being used as proxies
to paint the inflation picture.
    Euro zone consumer good companies, for example, boosted
operating margins to an average of 10.7% last year, up by a
quarter over 2019, before the global pandemic and the war in
Ukraine, Refinitiv data shows. 
    The 106 companies included in the survey ranged from French
resort owner Pierre et Vacances  PVAC.PA  to carmaker Stellantis
 STLAM.MI  to luxury goods group Hermes  HRMS.PA  and Nordic
retailer Stockmann  STOCKA.HE .
    Similarly, profits rather than labour costs and taxes have
accounted for the lion's share of domestic price pressures in
the euro zone since 2021, according to ECB calculations based on
Eurostat data.
    DETACHED DISCOURSE
    Indeed, wages have been growing far more slowly than
inflation, implying a 5% drop in the standard of living for the
average employee in the euro zone compared with 2021, according
to ECB's calculations. 
    That's pretty much the opposite of the wage-led inflation
that characterised the 1970s, an era which has become the most
widely used point of comparison in the public debate about
appropriate 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 example, wages were mentioned 14 times in ECB President
Christine Lagarde's latest news conference while margins didn't
get a single mention. Her deputy, Luis de Guindos, also warned
that the ECB needed to be careful because labour unions might
demand excessive pay rises. 
    "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
raised by former Federal Reserve Bank vice-chair Lael Brainard,
who is now President Joe Biden's top economic adviser, and
Democratic senators Elizabeth Warren and Bernie Sanders.     
    Even inside the ECB, labour representatives demanding higher
pay for central bank staff have distanced themselves from what
they described as the institution's "anti-worker bias".
    They cited, among others, a paper by researchers at the
International Monetary Fund showing that accelerating wages have
not historically led to a wage-price spiral.
    
    PROFIT VS WAGES
    ECB policymakers gathered in Finland went through similar
data sets showing that profits had outpaced wages thanks to
savings built up during lockdowns being spent, but also because
of companies' power to set prices, the sources said.
    With those savings now being depleted and competition
returning, things may be changing for ECB policymakers who have
been calling for a redrafting of the inflation narrative.
    In January, Portuguese central bank governor Mario Centeno
was among the first to warn about the risk of a very clear
increase in profit margins, saying it should be brought up the
European policy agenda. 
    ECB board member Fabio Panetta later said workers had borne
the brunt of the surge in prices while, on balance, company
mark-ups had remained stable, or even increased in some sectors.
    Wages are accelerating, with the ECB's forward-looking wage
tracker anticipating a rise of nearly 5% in 2023 for contracts
signed in the last quarter of 2022. But that won't offset the
massive drop in real wages over the past year, analysts said.
    "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
liberalisation of labour markets," said Mattias Vermeiren, a
professor of international political economy at the Ghent
Institute for International and European Studies.
    During the last inflation crisis in the 1970s, nearly 70% of
economic output went to employees, with just over 20% going to
profits, according to Eurostat data. Now, labour's share stands
at 56% with a third going to profits.
    The ECB policymakers went over those differences at their
Finnish retreat, though their tentative conclusions were dotted
with caveats, the sources who attended the meeting said.
    Some argued that furlough schemes during the pandemic may
buttress incomes, the sources said, and that a sustained period
of high inflation may raise salary demands in a way that models
developed during periods of stable prices fail to predict. 
    And the interest rate doves might have their work cut out
after data showed inflation in France, Spain and Germany
exceeded expectations last month.

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ECB's top three shareholders chart different paths for rates   
 urn:newsml:reuters.com:*:nL8N3595ZU
Unexpected inflation jump adds to ECB headache     urn:newsml:reuters.com:*:nL1N3580T6
Euro zone companies to slow price increases this year, ECB poll
shows     urn:newsml:reuters.com:*:nL8N34J1UV
Profits, not wages, have driven inflation    https://tmsnrt.rs/3Zby2Uu
    ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
 (Additional reporting by Balazs Koranyi, Chris Steitz, Philip
Blenkinsop, Victoria Klesty, Joanna Plucinska and Thomas Leigh;
Editing by David Clarke)
 ((francesco.canepa@thomsonreuters.com; 004906975651247; Reuters
Messaging: francesco.canepa.thomsonreuters.com@reuters.net))