Although US consumer prices showed further signs of easing for consumers in April in April, there are still factors keeping inflation high – and companies could benefit from this.
“We had a really unfortunate situation where we had three very, very different waves of inflation that were being caused by very different things,” Paul Donovan, chief economist at UBS Global Wealth Management, told Yahoo Finance (video above). “And they just came one after the other. So it looks like you’ve had this continuous period of inflation.”
The first wave, particularly in consumer discretionary, “was demand driven,” Donovan explained. “It’s over. Durable goods prices in the States are falling. There is real deflation.”
This was followed by a second wave of supply-side inflation, he added, “and that was the energy shock that followed from the war in Ukraine.” And then “the third wave of inflation — the one we’re seeing now — is this unusual profit-driven inflation story.”
Sometimes called “excuse me” or “greed inflation,” profit-driven inflation occurs when consumer-centric firms at the end of the supply chain persuade buyers to accept price increases by pointing to plausible explanations (e.g., historically elevated inflation). However, Donovan said the real reason for these elevated prices may be expanding margins and maintaining high investor sentiment rather than increased input costs.
“They’re excuses,” Donovan said. “It’s a disguise.”
A shopper who complains that groceries have recently become significantly more expensive holds the receipt for his purchase in a discount supermarket in Berlin, Germany, June 15, 2022. (Photo by Sean Gallup/Getty Images)
Why inflation persists
The main drivers of higher prices are the cost of goods sold – which includes both material and labor costs – and corporate profits.
Luckily for consumers, material prices have come down tremendously. The World Bank expects commodity prices to fall 21% in 2023 compared to 2022 — which it noted would be the sharpest fall since the COVID-19 pandemic.
The story goes on
However, the prices are still well above the average level of the years 2015-2019. In the first quarter of 2023, certain companies continued to raise prices even though comparable sales volumes were flat or declining.
“I think what you’re seeing is, firstly, we’ve obviously adjusted some prices to cover the inflation that we’re struggling with,” Hugh Johnston, CFO of PepsiCo (PEP), told Yahoo Finance. “As consumers move to smaller pack sizes, that’s having a bit of an impact on volume as well. But overall the demand for our products is still quite high.”
Elevated labor costs may be the bigger dilemma for an inflation-fighting Federal Reserve — and a viable explanation for companies enforcing rate hikes.
“What I think is going to be the bigger story this year for the broader economy, particularly the Fed, is going to be these higher labor costs,” Kevin Gordon, senior investment strategist at Charles Schwab, told Yahoo Finance.
“Look at the unit labor cost growth – it’s still well above trend, the trend before the COVID-19 crisis – and the fact that you’re not seeing any real slowdown or no productivity growth because it’s still strong is negative,” he said.
“That convergence is going to be really important, I think, because companies can only sustain these higher labor costs for a limited time, especially if they don’t get that revenue back and don’t get that revenue increase.”
However, corporate profits have also played a major role in price increases since the upheavals caused by the corona pandemic began.
According to an analysis published by the Economic Policy Institute, corporate profits replaced unit labor costs as the largest contributor to unit price growth in the non-financial corporate sector from the second quarter of 2020 to the fourth quarter of 2021 compared to historical averages from 1979-2019.
“[Corporations] “Insert a margin increase,” Donovan said. “And you can see that, for example, in the rise in retail profits as a percentage of GDP. This is one instance where we see this spread widening under the guise of ‘oh, it’s a general inflation problem’. We can not do anything about it.’ But actually they are increasing their margin and basically convincing consumers to accept that.”
How long before companies reconsider the “sorry”?
Another reason companies may feel comfortable raising prices is the continued strength of consumers.
During the first quarter of 2023, numerous company executives said that US consumers are “healthy” and their spending is “resilient,” while explaining price hikes and earnings-protection efforts to investors and equity analysts.
“After slowing somewhat in the second half of 2022, we saw the pace of payments pick up again in the first quarter, particularly in the latter parts of the quarter,” Bank of America (BAC) CEO Brian Moynihan said during Q1 -Results of the company’s claim. “Consumers’ financial health generally remains healthy. They are employed at generally higher wages, continue to have strong bank balances and have good access to credit.”
In June, however, Moynihan acknowledged that spending had “slowed down” after a series of rate hikes by the Federal Reserve. There is also evidence that higher prices are weighing on consumer confidence.
For example, consumer sentiment plummeted 7% in May, erasing “nearly half the gains made from last June’s historic low,” said Joanne Hsu, director of polls at the University of Michigan, in her latest report. “However, consumer views on their personal finances have changed little compared to April, with resilient income expectations supporting consumer spending for now.”
People shop at Lincoln Market in the Prospect Lefferts Gardens neighborhood of the Brooklyn borough of New York on June 12, 2023. (Photo by Michael M. Santiago/Getty Images)
While profit-driven inflation can help secure near-term profits for a company, it could also damage a brand’s image if consumers see the reasons behind price increases as disingenuous – especially as social media offers consumers a new way to resist .
Donovan said a company’s brand could be damaged if it was accused of “profiteering” at a time when people are suffering.
“Remember, we’ve had two years of negative real wage growth in developed countries — people are feeling the pain,” he said. “So I think social media can help fuel profit-driven inflation by creating excuses that businesses can use. But they can also work by jeopardizing brand values and causing companies to reconsider some of their pricing strategies.”
Because of this, profit-driven inflation won’t last forever, Donovan said.
“Eventually either governments or consumers realize that’s happening and they say, ‘Wait a minute, that’s not fair,’ and then you start hurting brand values,” he said. “You are seen as a scammer or an unfair consumer. And this is exactly where we are now.”
Brad Smith is a moderator at Yahoo Finance. Follow him on Twitter @thebradsmith.
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