"Inflation has proved more stubborn than central banks bargained for when prices started surging two years ago. Now some economists think they know why: Businesses are using a rare opportunity to boost their profit margins.
Figures released Tuesday by the European Union's statistics agency showed consumer prices in the eurozone were 7% 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 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 pandemic and the energy, food and raw-material bottlenecks that followed sanctions on Russia 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 2022 than rising wages.
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," Ms. Weber said. "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 also have 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," he said.
The latest round of earning calls by large consumer-facing companies stressed that. Food and health company Nestle last week said it boosted sales by 5.6% in the first three months of the year despite raising its prices by 9.8%. Its CEO said the company simply was matching cost increases over the previous two years. "We're still in the process of catching up with some of the hits we've taken," said Mark Schneider.
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 because 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 fewer firms. "There is not enough competition in the food sector, especially in distribution," said Ludovic Subran, chief economist at Allianz.
Not all businesses are opportunistically boosting their margins, and Ms. Weber said that when some do, it can cause problems for others that are closer to the final consumer and are at greatest risk of facing a backlash.
In recent earnings calls, some executives said consumers are becoming more resistant to price rises.
"We will probably see pricing moving down," said Francois-Xavier Roger, Nestle's chief financial officer." [1]
When consumers stop accepting the prices, the need to push sanctions on Russia will disappear, and the conflict in Ukraine will stop.
1. World News: Stubborn Inflation in Europe Blamed Partly on Profit Motive
Hannon, Paul. Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]. 03 May 2023: A.9.
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