Greedflation is key culprit thats more powerful than the wage-price spiral in driving up costs
The European Central Bank is catching up to an inflation risk thats proving far more powerful than the wage-price spiral that policymakers have been worrying about.
Officials speaking this month increasingly highlight the importance of surging profits in the euro zones most severe spell of inflation, with President Christine Lagarde warning in late March of a tit-for-tat dynamic where widening corporate margins propel salaries and prices ever higher.
So-called greedflation is threatening to complicate efforts to rein in consumer-price growth, meaning the ECB may have to do more to hit its 2% target just as officials flag that the end of their most aggressive cycle of interest-rate hikes is approaching.
There are clear risks for the inflation decline to be slower than previously anticipated due to rising corporate margins, said Piet Christiansen, chief strategist at Danske Bank in Copenhagen.
Thats because companies tend to raise prices more quickly to offset higher input costs than they cut them when their expenses fall, allowing them to run larger margins for longer, he said.
These dynamics are very difficult for the ECB to address, Christiansen said.
While margin expansion wont be as rapid this year as it was in 2023, any sort of conflict between wages, profits and the public sector would be extremely detrimental to the future and it could produce a reaction of the ECB in terms of our monetary policy, Vice President Luis de Guindos said Wednesday.
Corporate profits have been a bigger driver of price gains than labor costs for some time since the start of 2021, according to Bloomberg Economicss Maeva Cousin. She calculates that swelling earnings generated more than two-thirds of inflation at the end of last year.
Already accused of acting too sluggishly as prices began their post-lockdown ascent, margin expansion only emerged as a clear concern at the ECB in recent months and only really came to the fore at Marchs policy meeting.
Many firms had been able to raise their profit margins in sectors faced with constrained supply and resurgent demand, Chief Economist Philip Lane told his colleagues, arguing that wages had had only a limited influence on inflation over the past two years and that the increase in profits had been significantly more dynamic.
A case in point is Latvia, where inflation has been among the 20-nation euro zones fastest. Central bank Governor Martins Kazaks sees some firms there raising prices just because they can.
Thats why the Governing Council continues to raise rates in a situation where the harmonized index of consumer prices is beginning to decline under the influence of the decline in global energy prices, he said.
Shoppers can play their part, too, according to Kazaks, advising that they be more selective in purchases and seek out better deals.
Some of his colleagues have played down the danger. Croatias Boris Vujcic said last week that weaker economic growth will erode companies ability to raise prices further.
Speaking a day earlier, Executive Board member Isabel Schnabel acknowledged that the ECB didnt pay enough attention to profits, but said they probably cant set off the same kind of dreaded spiral that wages can.
With profits, theres stronger self-correction because people have to pay these higher prices somehow, she said. I dont see that you can extrapolate this continuously into the future, but you have to monitor it and were monitoring it more closely than we used to.
The ECB may slow the recent pace of its interest-rate hikes on May 4, taking the deposit rate to 3.25% with a quarter-point move. It predicts inflation will ease to 2.8% by year-end from more than 9% at the start, before falling back to target in the second half of 2025.
But with both businesses and consumers trying to shield themselves against rising costs, Oscar Arce the ECBs director general for economics and research cautions that an upward price spiral could yet emerge.
The mutually reinforcing feedback between higher profit margins, higher nominal wages and higher prices risks strong second-round effects, he and his colleagues wrote in a blog post.
