- Central banks are worried businesses are increasing their margins under the cover of inflation
- But as demand cools, consumers will prove unwilling to accept this
If you have ever wondered whether firms are using inflation as cover for sneaky additional price increases, you are in good company: the European Central Bank (ECB) and the Bank of England (BoE) have their suspicions, too. We have arguably entered the era of ‘greedflation’.
ECB economists noted last week that “many companies are apparently able to expand their profit margins without facing significant losses of market shares”. They added that high energy prices also “make it harder to tell whether higher prices are caused by higher costs or higher margins”. And the problem is not unique to Europe. BoE rate setter Catherine Mann told Bloomberg last month that she was “concerned about the extent to which there is strong pricing power among firms and acceptance of those price rises by a lot of consumers”.
The ECB estimates unit profits rose by 9.4 per cent in Q4 and made up more than half of the domestic price pressures in that quarter. This is a bit of a red flag: based on historic patterns, we would expect today’s slow economic growth and worsening terms of trade to dampen profits. Instead they are increasing. There is growing concern that firms are using the cover of persistent inflation to push through CPI-busting price increases, a phenomenon described by some as ‘greedflation’.
Yet diagnosing a true case of 'greedflation' is difficult. Firms have faced rapidly escalating input costs; and have increased prices for a variety of reasons. Some sectors will also have increased margins in an attempt to recoup losses from the shocks of the past three years, while others will look to build buffers given the highly uncertain environment. ING economists said last week that widening profit margins in Germany are contributing to inflationary pressures, and added that firms “never waste a good crisis”. Nevertheless, they note that “whether it is 'greedflation' in the purest meaning of the word or there are other reasons, we cannot know entirely”.
Inflation-beating price hikes make things even harder for consumers wrestling with the rising cost of living. As a result, the ECB is worried about “tit-for-tat inflation”, which would see workers try to offset rising prices by asking for substantial wage increases. Their figures suggest that unit labour costs grew less than profits in Q4 last year, but still rose by 4.7 per cent.
Economists at ING said that with evidence of profit-price and wage-price spirals beginning to materialise, core inflation will remain stubbornly high over the months ahead. They expect the ECB to continue hiking interest rates until the summer as a result. The Bank of England also expressed concerns about spiral effects in its last monetary policy report. The Bank said that inflation persistence could reflect “greater confidence by businesses that they can pass on cost increases, and a desire by some employees to try to offset the downward pressure on their real incomes via higher nominal pay”. Inflation dynamics like these could mean sticky core inflation ahead (see chart) as a result.
But if price growth drops back as fast as expected this year, the feedback loop could be broken: wages will need to rise less to keep up with inflation. What’s more, higher interest rates will start to feed through and reduce consumer demand, which could dampen firms’ pricing power.
This might be happening already. Food and beverage inflation rose to 18 per cent last month in the UK. Supply conditions have been tough, but analysts at Pantheon Macroeconomics said that it would be a stretch to link these big increases to the impact of poor European harvests: “instead, supermarkets appear to have widened their margins”.
Yet, according to Pantheon, people are curtailing their consumption of goods that have risen most quickly in price, while discounters Lidl and Aldi have seen their market share soar. They add that “shoppers are not brand loyal but will flock to where prices are lowest”. For the same reason, quarterly results from the likes of consumer goods companies continue to be closely scrutinised for signs of shoppers trading down. Firms that are engaging in ‘greedflation’ could yet find that it backfires.
