MADRID – According to the OECD, Spain is the European country where corporate profits have the greatest influence on inflation. About 90% of the internal pressure is due to price increases implemented by companies.
Wages now had a moderate impact in contrast to previous episodes of inflation. “Corporate earnings momentum is markedly higher than in previous inflation periods. We are seeing a recovery from the economic collapse during the pandemic, but the current level is already 3% higher than before Covid,” said Raymond Torres, director of Business Cycle and International Analysis at Funcas, in an interview with the newspaper NIUS. It is important to emphasise that these price increases are not uniform within companies, as there are significant differences between economic sectors.
Spain most extreme case of EU countries
OECD data shows that wages, the usual ‘suspects’, are not the main culprits for persistent inflation in many European countries, an anomaly which is also visible in France, Italy, the Eurozone and the UK. Spain, however, is the most extreme case.
The rising prices are in line with the onset of the energy crisis. In the Eurozone, the origins of internal inflation are more balanced. So what makes Spain so unique? This is partly because Spain’s corporate sector was one of the hardest hit during the pandemic, with the biggest drop in GDP among major European economies.
The OECD report offers two general explanations for this increase in corporate profits seen in many countries:
- Some studies suggest that companies are anticipating the cost increase they saw coming even before the invasion of Ukraine.
- Others see it as a reflection of the lack of competition in some industries and the pricing power of some companies.
“It is important for economic policy to understand why we are seeing these increases,” the OECD says. It is also noteworthy that a “disproportionate” share of corporate inflation comes from sectors such as mining, electricity, gas and water management. “These sectors make up only 4% of the average economy, but are responsible for more than 40% of the 2022 earnings growth.” In the last quarter of 2022, the manufacturing and service sectors have also joined this group.
The important role of pandemic
The pandemic also plays an important role in this story. The return to normal life has in many cases created greater demand than supply, giving companies greater pricing power.
“Many companies have raised their rates above the increase in costs,” Isabel Schnabel, member of the ECB’s Executive Committee, replied in an interview this week. “This can lead to a profit-wage-price spiral, as opposed to a simple price-wage spiral.”
Operating margins most reactive
It has traditionally been thought that an inflationary cycle arises with a rise in the price of one or more products and a rapid reaction of wages, which in turn causes more price increases in the products. This is what happened in the 1970s with the oil crisis, which is why economists have been warning for months about these “second round” effects targeting wages.
But it turns out that corporate margins are now the most reactive to the rise in energy and commodity prices. That’s why the possible inflation spiral starts with the word “profits/margins”.
At the stage we are in, wage increases are expected to restore some purchasing power as companies have improved their earnings. In Spain, social partners have agreed on a wage increase of 10% over the next three years.
However, it is not yet known how the companies will react: “Will they pass on this cost increase in prices or will they absorb it by reducing their margins? “That largely depends on how strong the demand for goods and services remains,” Torres replies. “If companies see that they can continue to raise prices without their sales falling, they probably will.”
High inflation fuels wage demands
The environment of interest rate hikes that the ECB has introduced to the euro area does not appear to be the most favourable for sustaining strong consumer demand for household goods and services. This can reduce the pressure and force price reductions in the companies.
“Now it’s time for salaries, but getting everything back is not possible,” says Torres de Funcas. “Someone – workers and companies together or separately – have to bear the costs of rising growth.