Frankfurt, Huddled in a retreat in a remote Arctic village, European Central Bank (ECB) 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, Reuters reported.
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 more than 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 fueled 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.
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 to carmaker Stellantis to luxury goods group Hermes and Nordic retailer Stockmann.
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.
Source: Bahrain News Agency