Financial issues moves into new phase: from profits to wages

The eurozone’s inflation challenge is moving into a new phase, where the driver of domestic price pressures is shifting from company profits to wages, officials at the European Central Bank said this week as they tried to lay the groundwork for a long period of high interest rates.

Workers, who have borne the brunt of high inflation in the eurozone, are expected to recoup some of their lost purchasing power by getting wage raises this year. That follows a year when companies were able to grow profits amid rapidly rising prices and demand for services, such as restaurants and travel, after pandemic lockdowns.

This year, wages are expected to catch up, officials at the bank said in recent days.

That adds to the challenge that policymakers face because wages adjust slowly and risk making inflation even more persistent, keeping it above the central bank’s 2% target. That could force them to take harsher action to slow the economy.

But policymakers are hopeful they can avoid this scenario and don’t believe the region is in a wageprice spiral, where wages chase prices higher and inflation risks running out of control.

“We can see wages growing quite strongly but inflation still dropping,” Philip Lane, the chief economist of the bank, said in an interview Wednesday on the sidelines of the bank’s annual conference in Sintra, Portugal. “Because the profitability was so high last year, in the aggregate, there is room for profits to fall to absorb some of those wage increases.”

But crucially, achieving this goal depends on companies actually letting their profits absorb higher wage costs and not trying to pass them on to customers through higher prices.

This is just the latest concern raised by the central bank about corporate profits and inflation. Earlier this year, other policymakers at the bank, including executive board member Fabio Panetta, warned that companies might keep trying to increase their profit margins, even as their costs were falling, which would prolong inflation.

From the middle of last year to the end of March, about 60% of domestic price pressures have come from profits, data published Thursday by the central bank showed.

This year, “we do think we’re going to start to see firms realizing that they’re hitting the limit of what their customers can absorb,” Lane said.

As profits have become essential to determining the outlook for inflation, the European Central Bank has stepped up its efforts to acquire data that is normally only revealed with a long time lag and little detail. This year, the central bank started tracking the quarterly calls when company executives discuss financial results with analysts as part of the policysetting process, Lane said.

Headline rates of inflation in the eurozone have dropped considerably from their peak last year, and Thursday, data showed that Spain’s inflation rate fell below 2% in June. But other measures of domestic price pressures are still quite strong. Inflation data for the whole eurozone for June is set to be published Friday. Economists surveyed by Bloomberg expect the headline rate to decline to 5.6%, from 6.1% in May, while core inflation, which excludes energy and food prices, is expected to rise to 5.5% from 5.3%.