After months of fretting about whether workers’ pay rises would keep inflation uncomfortably high, central bankers in Europe have another concern: large company profits.
Companies that push up their prices above and beyond what is necessary to absorb higher costs could be fueling inflation that central bankers need to combat with higher interest rates, a policymaker at the European Central Bank warned, suggesting that governments might need to intervene in some situations.
Policymakers, long preoccupied with higher pay prompting companies to raise their prices, generating a wage-price spiral, should also be alert to the risks of a so-called profit-price spiral, said Fabio Panetta, an executive board member at the E.C.B. At a conference in Frankfurt last week he pointed out that in the fourth quarter of last year half of domestic price pressures in the eurozone came from profits, while the other half stemmed from wages.
His concerns about profits have been echoed in recent remarks by the E.C.B.’s president, Christine Lagarde, and the Bank of England governor, Andrew Bailey. Although inflation in Europe has begun to ease from last year’s double-digit peaks, the rates remain far above 2 percent, the target of most central banks.
“There’s a lot of discussion on wage growth,” Mr. Panetta said in an interview this week. “But we are probably paying insufficient attention to the other component of income — that is, profits.”
Profit margins at public companies in the eurozone — measured by net income as a percentage of revenue — averaged 8.5 percent in the year through March, according to Refinitiv, a step down from a recent peak of 8.7 percent in mid-February. Before the pandemic, at the end of 2019, the average margin was 7.2 percent. Profit margins have grown in recent years among energy companies and consumer discretionary goods companies, such as luxury retail brands Hermès and LVMH.
There has been a similar phenomenon in the United States, where companies reported wide profit margins last year despite the highest levels of inflation in four decades. To protect those margins as costs fall, some companies are focusing on offering premium products.
Companies could be increasing prices because of higher input costs (the expenses involved in producing their goods or services), or because they expect future cost increases, or because they have market power that allows them to raise prices without suffering a loss of demand, Mr. Panetta said. Some producers could be exploiting the imbalances in supply and demand following the pandemic lockdowns or taking advantage of this period of high inflation, which makes it more challenging for customers to be sure of the cause of price increases.
“Given the situation which prevails in the economy, there could be ideal conditions for firms to increase their prices and profits,” he added.
“I’m not here to pass a judgment on how fair or unfair” price-setting is, Mr. Panetta insisted, but rather to explore all of the causes of inflation. Mr. Panetta is a member of the E.C.B.’s six-person executive board that sets policy alongside the governors of the 20 central banks in the eurozone, and a former senior deputy governor of the Bank of Italy.
There are sectors where “input costs are falling while retail prices are increasing and profits are also increasing,” Mr. Panetta said. “So this is enough to be worried as a central banker that there could be an increase in inflation due to increasing profits.”
The average rate of inflation for the 20 countries that use the euro has been falling for five months — to 6.9 percent in the year through March — but core inflation, which excludes volatile energy and food prices, a measure used by policymakers to assess how deeply inflation is embedding in the economy, has continued to rise. Analysts predict the E.C.B. is edging closer to pausing increases in interest rates, which are now at the highest since 2008, because energy prices have fallen substantially and the recent outbreak of turmoil in the banking sector might slow the economy.
But policymakers have said they want to see evidence of core inflation slowing down. Firms raising prices to expand their profits could slow that decline, Mr. Panetta said.
Central bankers tend to focus more on wages and the risk that jumps in pay will lead to persistently high inflation, especially in Europe where wages tend to change more slowly than in the United States. The E.C.B. has been scrutinizing the data on wages, even developing new tools to measure changes in wages more quickly.
But this intense focus on wages has provoked some criticism. Mr. Bailey of the Bank of England was called out last year for suggesting workers should show restraint in asking for higher wages.
As inflation persists, attention has turned to corporate profits. There is uncertainty about what will happen as prices for energy and other commodities keep falling: Will companies restrain themselves from raising prices further?
Last week, Ms. Lagarde raised the issue of profits, saying there needed to be fair burden sharing between companies and workers to absorb the hit to the economy and income from higher energy prices. “If both parties attempt to unilaterally minimize their losses, we could see a feedback mechanism between higher profit margins, wages and prices,” she said.
In Britain, Mr. Bailey told companies to bear in mind that inflation is expected to fall when setting prices. Across the Atlantic, last year Lael Brainard, who was then the vice-chair of the U.S. Federal Reserve, suggested that amid high profit margins in some industries, a reduction in markups could bring down inflation.
In Europe, companies were able to protect their profit margins last year from high inflation more than expected, Marcus Morris-Eyton, a European equities analyst at Allianz Global Investor, said. “Corporates had more pricing power, at an average level, than most investors expected,” he said.
This year, he expects there will be more variety in profit margins, as not all sectors will be able to keep prices high. “The average European company will face far greater margin pressure this year than they did last year,” Mr. Morris-Eyton said. That’s because of higher wage costs but “partly because as input costs have fallen, there is greater pressure from your customers to lower prices.”
Last year, record-breaking profits by energy producers was the source of ire for consumers who faced high energy bills, while governments spent billions to protect households from some of those costs. But as energy prices have fallen, consumers are still experiencing rising food prices. In the eurozone, the annual rate of food inflation rose to 15.4 percent in March, up from 15 percent the previous month.
“To a certain extent there’s been also an opportunistic move by some big manufacturers to actually increase their prices, sometimes above their own cost increases,” said Christel Delberghe, the director general of EuroCommerce, a Brussels-based organization representing wholesale and retail companies across Europe. “It’s kind of a free-riding on a high price environment.”
It’s one of the factors squeezing profits at retail companies, alongside the rising costs of products they buy and resell and higher cost of operations.
There is a notable disparity in profit margins between food producers and retailers, a traditionally low-margin business. The food and consumer goods conglomerates Unilever and Nestlé each reported profit margins in the high teens for 2022, while French supermarket company Carrefour reported a margin of about 3 percent for the same period. Unilever raised prices for its products by more than 11 percent last year and Nestlé raised prices by more than 8 percent, but in both cases the companies said that they had not passed on all the effects of higher costs to consumers.
Ms. Delberghe said she feared the blame for higher prices was unfairly going to land on retailers. “We’re extremely worried because indeed there is this perception that prices are going up and that it’s very unfair,” she said. Retail businesses are getting a lot of pushback, including from governments trying to take action to stop price increases in stores.
At the E.C.B., Mr. Panetta said governments should step in where necessary, in part because their fiscal support programs have helped keep profits high. “If there is a sector in particular where market power is abused or there is insufficient competition, then there should be competition policies that should intervene,” he said.
But it was also a message to companies.
“It should be clear to producers that strategies based on high prices that increase profits and inflation may turn out to be costly for them,” he said.
The cost? Higher interest rates.
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