- The evidence for ‘greedflation’ has so far been weak
- But new BoE data suggests margin rebuilding could drive inflation persistence next year
Earlier this year, there was a great deal of talk about ‘greedflation’: the idea that companies were using inflation as a cover to put their prices up, thus fuelling inflation further. Although it sounded plausible, the evidence proved less convincing. The OECD found only modest evidence of higher profits, while Bank of England (BoE) economists concluded that “the contribution of rising business profits to recent inflation is small”. What’s more, a recent report from the central bank found that only 30 per cent of firms saw any increase in their profit margins between Q1 2022 and Q1 2023. Over 40 per cent saw a decrease, while the remainder saw no change.
‘Greedflation’ might feel like a relic from an earlier economic time, but it would be premature to write it off entirely. Although the rate of inflation has fallen back from the double-digit peak it reached last autumn, forecasters still expect it to remain above target for the next 18 months. The still-rising price level could provide companies with the ‘excuse’ they need to engage in a bout of price hikes.
According to survey data collected by the BoE, only a tiny proportion of companies expect profit margins to be squeezed as badly this year as they were in 2022 and, as the chart shows, almost half expect their margins to expand over the next 12 months. Almost a third of these (13 per cent in total) expect to see a ‘large increase’ in profit margins of over 3 percentage points.
BoE economists took a closer look at the survey data as part of research for their 'Bank Underground' website. Businesses with the lowest operating profit margins saw the biggest drop last year, and expect only a partial recovery. By contrast, companies in the top 10 per cent saw resilient margins over the same period, and now expect them to grow over the months to come.
Tellingly, the economists found “some evidence that companies that expect to increase margins also expect higher price growth over the year ahead”, and added that “these differences suggest that margin rebuilding could make some contribution to inflation persistence going forward”. Taken together, this all starts to sound a lot like greedflation.
There are several caveats. It is worth stressing again that only one in eight companies anticipate a large increase in margins, which should limit the impact that margin rebuilding will ultimately have on the general price level. But businesses have been prone to understate price increases in the past. The data comes from the BoE’s Decision Maker Panel, which questions around 2,500 UK financial directors. According to economists at Dutch bank ING, “policymakers are also acutely aware that firms have been saying one thing about expected price increases, but when it comes down to it, appear to end up moving more aggressively'”. ‘Realised’ price growth has been consistently higher than 'expected' figures, according to this survey.
The BoE economists also point out that “the relationship is not necessarily causal”, meaning that changes in margins and price growth "could both be driven by a third factor”. The mantra of ‘correlation does not equal causation’ is crucial here.
Earlier this summer, Capital Economics produced a report on greedflation that found that companies had indeed been able to pass higher input costs on to consumers, rather than absorbing them at the cost of lower margins. But according to Neil Shearing, group chief economist, “this reflects the overall strength of aggregate demand relative to supply, and it is this that is driving inflation”. If resilient demand is driving both higher profits and higher inflation, calls of greedflation risk “muddling symptoms and cause”.
If so, we might find companies' expectations for the year ahead start to look increasingly optimistic if the UK economy skirts a recession. As the full impact of interest rate hikes feeds through to the economy, businesses may see demand falter, and struggle to bolster their profit margins as planned over the year ahead. They will face scrutiny in any case: although inflation may be slowing, it will not be enough to bring an end to the greedflation debate.
