June 29 (Reuters) – A key measure of corporate profitability in the euro zone rose to a record high last quarter, keeping up pressure on inflation as the long-awaited drop in business margins is delayed further, a European Central Bank (ECB) paper showed on Thursday.
Businesses jacked up prices ahead of cost increases last year to push inflation to double digit territory by the autumn, forcing the ECB into rapid rate hikes to cool demand so firms would have to relent and start absorbing higher wage demands.
While the ECB often blames quick wage growth for the inflationary pressures, the GDP deflator – a measure of changes in price of all goods and services – rose to four times its historic average last quarter with profits, not wages, contributing most of this.
“In the first quarter of 2023, the annual growth rate of the euro area GDP deflator reached a record high of 6.2%, up from 5.7% in the previous quarter, having stood at a low of 0.6% in the second quarter of 2021,” the ECB said in an Economic Bulletin article.
“The contribution from unit profits has been particularly large over the last three quarters, accounting for roughly 60% of total growth in the GDP deflator,” the ECB added.
Traditional economic thinking would have pointed to weaker profits given the bloc suffered a recession over the winter but the unique nature of the shocks overwrote the rule book.
Households are still sitting on ample savings accumulated during the pandemic, so they keep spending, while energy price volatility created an easier excuse for firms to raise prices.
Anticipation of more energy shocks is motivating companies to buffer against further shocks.
Even if a drop in margins is not yet evident, the ECB repeated its long-held view that this will eventually come and businesses will start absorbing some of their workers’ extra wage demand, thereby taking pressure off the ECB to raise rates.
“Looking ahead, the unwinding of pent-up pandemic-related demand, the easing of supply bottlenecks and the dampening impact of monetary policy tightening should mean that firms are under more pressure to absorb strong wage growth and the ensuing growth in unit labour costs using unit profits,” the ECB said.