Central bankers warn companies on fatter profit margins

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Central banks are turning their attention to companies using high inflation as an excuse to boost their profit margins, warning that businesses’ price gouging risks triggering persistent cost pressures.

Profit margins of U.S. companies hit their highest level since the aftermath of the Second World War II in 2022, research by economists at the University of Massachusetts Amherst has found.

Eurozone businesses have also enjoyed the biggest expansion in their profitability since the 2008 global financial crisis over the past two years, according to research by France-based bank Natixis.

“Pent-up demand during the [COVID-19] pandemic meant people were less price sensitive as they came out of lockdowns,” says Dirk Schumacher, head of European macro research at Natixis. “So, companies could take advantage of high inflation to boost profits.”

The focus on fatter profit margins marks a shift among policymakers who have been concerned about the risk of 1970s-style wage-price spirals, in which companies have to raise prices to cover increasing employee costs.

“Part of the high inflationary pressure may indeed be due to the greater market power of companies,” Isabel Schnabel, European Central Bank (ECB) executive board member, told the Financial Times.

Her remarks come a few weeks after the ECB added a reference to the impact of rising profit margins on inflation to its monetary policy statement for the first time.

Esther Lynch, general secretary of the European Trade Union Confederation, says: “I’m pleased that central banks are finally waking up to the fact that inflation is being driven by profits and not by wages.”

She adds: “Corporations, particularly those in the energy and food sectors, have caused inflation by using supply bottlenecks as a cover to hike up their prices.”

U.S. Federal Reserve Board chair Jay Powell was rebuked for ignoring the issue during his testimony to Congress this month.

“The Fed can’t force corporations to change their ways or rewrite the Wall Street business model on its own. But you could talk about it,” said Sherrod Brown, chair of the Senate banking committee.

Andrew Bailey, the Bank of England governor, urged companies a couple of weeks ago to refrain from price rises that could perpetuate high inflation just as its original causes – supply chain snarl-ups and the surge in commodity prices as COVID-19 restrictions were lifted – began to fade.

“When companies set prices, I understand that they have to reflect the costs that they face,” Mr. Bailey told the BBC. “But ... we do expect inflation to come down sharply this year.”

Unions seized on his comments. “The U.K. is in the grip of a profiteering epidemic,” said Sharon Graham, general secretary of Unite the Union.

But data published by the Office for National Statistics last month showed that once oil and gas producers were excluded, the profitability of U.K. manufacturing and service companies declined between the first and third quarters of 2022.

In Germany, the behaviour of Volkswagen, BMW AG and Mercedes-Benz Group AG, which have reported record profits over the past year, shows how supply bottlenecks, coupled with resilient demand, have allowed companies to boost their margins.

With semiconductor chips in short supply, companies focused on producing larger cars, as well as more electric vehicles. These are more expensive and profitable, as they can be sold to richer, less price-sensitive consumers.

Germany’s Big Three automakers have also been able to boost their margins by forcing makers of their components to absorb some of their higher costs for raw materials and transportation.

Andreas Wolf, chief executive officer of power-train maker Vitesco Technologies Group AG, says the carmakers’ dominance meant that only 80 per cent of its higher costs could be passed on. “It is not sustainable if we always swallow the cost increases.”

Mr. Wolf told the FT that the industry risked pricing people on lower incomes out of the market. “If [prices] continue to go up, mobility will no longer be affordable to everybody.”

The big question now is how long businesses will continue to raise their prices by large increments as energy costs and the price of other feedstocks fall back.

There are some signs they’re adjusting to lower demand caused by higher interest rates and the depletion of excess savings built up during the pandemic.

BMW had said this month that it expected price rises to taper off as orders had started to soften slightly in Europe this year.

Philip Lane, ECB chief economist, said last week that BMW’s statement was a signal that high-profit margins were likely to be squeezed by weaker demand, adding that competition should be boosted by the reopening of China’s economy after it ended its zero-COVID-19 policy.

“European companies know that they will lose market share if they raise their prices too much.”

Ms. Schnabel agrees that weaker demand was likely to reduce companies’ price gouging opportunities.

“If prices rise faster than wages over a longer period of time and real wages fall as a result, households will at some point no longer be able to afford the higher prices,” she says.

Other economists are more skeptical that companies in sectors with just a few big players will be able to resist the urge to use high inflation to boost their profits.

“If market imperfections are sufficient, with oligopolies in several sectors, it is still possible for companies to compensate for falling sales by raising margins,” says Eric Dor, an economics professor at the IESEG School of Management in Paris.

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