Why Is Inflation So Sticky? It Could Be Corporate Profits
Some companies might have been raising prices faster than their costs have increased, making it harder for inflation to fall, economists say.
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Figures released Tuesday by the European Union's statistics agency showed consumer prices in the eurozone were 7.0% higher than a year earlier in April, a pickup from March and more than three times the European Central Bank's target. However, the core rate of inflation—which excludes food and energy prices—edged down to 5.6% in April from a record high of 5.7% in March.
Inflation rates also remain uncomfortably high in the U.S. and many other parts of the world despite interest-rate rises that have gone further and been delivered more quickly than at any time since the 1980s.
There have been good reasons for businesses to raise their prices in recent months. The supply-chain disruptions caused by the Covid-19 pandemic and the energy, food and raw-material bottlenecks that followed Russia's invasion of Ukraine have pushed costs higher.
But there are signs that companies are doing more than covering their costs.
According to economists at the ECB, businesses have been padding their profits. That, they said, was a bigger factor in fueling inflation during the second half of last year than rising wages were.
Jan Philipp Jenisch, chief executive of construction-materials maker Holcim, said on a recent earnings call: "We are in that inflationary environment already for almost two years now…We have done the pricing in a very proactive way, so that our results aren't suffering. On the contrary, they are improving the margins."
One puzzle is why consumers have played ball. Usually, economists would expect any business that raised its prices to lose customers to competitors that don't, or not by as much.
But these aren't normal times. In rare situations—such as an economy's reopening after a pandemic—widespread knowledge that costs are rising allows businesses to raise their prices knowing that their competitors will act in the same way, according to a paper by Isabella Weber, assistant professor of economics at the University of Massachusetts, Amherst, and her colleague, Evan Wasner.
That is a pattern the two economists said has played out in an analysis of recent earning calls in which executives at U.S. businesses present their financial results to analysts.
"We do have to think about pricing differently," said Ms. Weber. "A cost shock, or bottlenecks can create an implicit agreement among firms that raise their prices, so they can expect others to act likewise."
Consumers have also been unusually willing to accept higher prices lately. Paul Donovan, chief economist at UBS Global Wealth Management, said businesses are betting that consumers will go along because they know about supply bottlenecks and higher energy prices.
"They are confident that they can convince consumers that it isn't their fault, and it won't damage their brand," Mr. Donovan said.
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Elsewhere, the desire to boost margins, rather than just cover increased costs, appears to be one reason why food prices have continued to rise rapidly in Europe.
Much of the surge in food prices since the middle of last year stems from higher costs, particularly for energy, since most food production is quite energy-intensive. But economists at insurance company Allianz have calculated that about 10% of the rise reflects the search for higher profits. They suggest that is possible because key parts of the food-supply chain are dominated by a small number of firms.
"There is not enough competition in the food sector, especially in distribution," said Ludovic Subran, chief economist at Allianz.
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In recent earnings calls, some executives said consumers were becoming more resistant to price rises.
"We will probably see pricing moving down," said Francois-Xavier Roger, Nestlé's chief financial officer.
Last month, Procter & Gamble said it had boosted its profit margins in the first three months of the year, thanks in large part to higher prices. It warned that there were limits to how far it could push that tactic before consumers switched to cheaper alternatives.
"We've made several adjustments to price gaps, not just versus private label, but versus branded competition as we've gone through this period of pricing, and we need to continue to be sensitive to that," said Jon Moeller, the company's CEO.
For Mr. Donovan at UBS, the period of profit-driven inflation might be coming to an end, in part because of rising public scrutiny.
"We are probably at a point where companies may be reassessing whether to push this," he said. "A reputation for being poor value for money stays for a long time."
