THE INFLATION STATISTICS released by the Central Statistics Office on 11 May show a modest decrease in annualised inflation in April 2023 relative to March 2023, from 7.7% to 7.2%. While the downward trend is welcomed, it is difficult to gauge its persistence in the months ahead.
By contrast, Euro-area inflation is expected to be 7.0 % in April 2023, up from 6.9% in March 2023 and a survey on inflation expectations released on 11 May by the European Central Bank (ECB) shows that Euro-area consumers’ inflation expectations increased significantly relative to previous months.
At the same time, uncertainty about inflation expectations 12 months ahead reached its highest level since the start of the survey in April 2020, while growth and employment expectations became slightly more negative.
These trends are an unwelcome development for the ECB, which decided to slow the pace of its interest rate increases last week. While energy prices have subsided over the last couple of months, several other trends can explain the persistence of this high inflationary environment.
First, increasing evidence suggests firm markups now account for a significant share of the rise in inflation.
For example, research from the Federal Reserve Bank of Kansas City shows that more than half of the 2021 inflation in the US could be attributed to corporate profits.
In the UK, a report from Unite found that the profit margins of the top 350 companies listed on the London Stock Exchange were 89% higher in the first half of 2022 as compared to the same period in 2019. In Europe, data from the ECB shows that the growth in corporate profits outpaced significantly that of wages over the period 2019 to 2022 across most sectors (with the exception of public administration and entertainment).
Strikingly, the highest increases in corporate profits were recorded in the mining and utilities as well as agricultural sectors. While initial supply bottlenecks caused by the Covid-19 pandemic, followed by the uncertainty regarding energy prices and upward pressures on wages, explained some of the initial hikes in mark-ups, many corporations now seem to have adjusted their pricing strategies to the high inflationary environment by increasing prices much more than the increase in their costs and, thereby, improving their margins considerably.
To look at one example, Jan Philipp Jenisch, chief executive of Holcim, a global building materials company, quoted in the Wall Street Journal said: “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.”
Economic theory would suggest that consumers should punish these businesses by shopping elsewhere or reducing their consumption, but in the context of the robust labour market, with unemployment figures in Ireland and Europe at historically low levels, this does not seem to happen.
At the same time, recent headlines in the Irish media broadcasting the various announcements made by four major supermarket chains (Aldi, Lidl, Supervalu and Tesco) about their intention to marginally decrease the prices of essential products like milk and bread are overshadowed by the fact the CSO price data shows, for example, a 24% year-on-year increase in the prices of milk.
The second trend that can explain the high persistence of inflation is the fact that favourable labour market conditions and lingering excess demand from the post-pandemic recovery meant consumer spending has remained high, despite the loss in purchasing power due to high inflation and the tightening of monetary policy, which is intended to curb spending.
However, as demand normalises, the conditions underpinning the extraordinary increase in corporate profitability in 2022 should not persist going forward, which should result in a decline in profit margins translating into lower inflationary pressures.
Oana Peia is an assistant professor in the School of Economics at University College Dublin and a Research Fellow at the Geary Institute for Public Policy Her research is at the intersection of macroeconomics and finance with an emphasis on the role that financial intermediaries play in the real economy.
Davide Romelli is an Assistant Professor of Economics at Trinity College Dublin, Ireland. He is also a Research Affiliate of IM-TCD (International Macro-TCD) and SUERF – The European Money and Finance Forum and a Fellow of the BAFFI-CAREFIN Centre, Bocconi University. His research focuses on international finance and macroeconomics, central banking and financial supervision.
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