Soaring corporate profits are a big part of the inflation problem, and keeping interest rates high is the best way to rein them in, according to Bloomberg’s latest poll of professional and retail investors.
About 90 per cent of 288 respondents in a Markets Live Pulse survey said companies on both sides of the Atlantic had been raising prices in excess of their own costs since the Covid-19 pandemic began in 2020.
Almost four in five said that tight monetary policy was the right way to tackle profit-led inflation.
One of the worst bouts of inflation in decades has spurred a search for explanations – with broken supply chains, big-spending governments and rising wages all shouldering some of the blame.
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But the surge in corporate mark-ups is another potential cause that deserves attention, and is now getting it.
Margins soared in the initial pandemic years, and have defied convention by remaining historically high since then.
That raises two key questions: Are fatter profits helping to entrench inflation and, if so, what should be done about it?
It is part of a wider debate about whether different kinds of price pressures need different tools to address them, instead of the one-size-fits-all response of higher interest rates.
MLIV Pulse survey participants largely took the view that monetary tightening by central banks was the appropriate response to profit-driven price rises.
About a quarter disagreed, offering alternative solutions including the use of corporate tax rates against price gougers and tougher anti-monopoly rules.
The retail sector has registered the most opportunistic pricing during the pandemic, about 67 per cent of respondents said. The energy industry came a distant second, with about a sixth of votes.
Those findings may reflect the fact that people buy basic consumption goods more often than bigger-ticket items, so they are likelier to notice when the prices jump – an idea known as “collision frequency”.
The unique circumstances of the pandemic – severe supply constraints, followed by an unprecedented burst of stimulus-fuelled demand – lie behind the widening of profit margins, which hit 70-year highs in the US.
That is unlikely to prove permanent, according to most survey respondents, who expect margins in the aggregate to recede to where they were before Covid – although the majority was only a slim one, at 53 per cent.
Standard economic theory holds that profit margins are “mean-reverting’’ – in other words, they tend to be pulled back to normal levels.
It is supposed to work like this: An industry with high profits should attract new entrants, with increased competition forcing margins lower.
But reality has rudely refused to conform. Margins were already elevated before the pandemic, and they are now even more so.
Various theories have sought to explain why this happened. Isabella Weber, an economist at the University of Massachusetts Amherst, argues that much of the recent inflation in the US was “sellers’ inflation”, stemming from the ability of dominant companies to exploit their monopolistic position to raise prices.
Ms Weber notes that “bottlenecks can create temporary monopoly power, which can render it safe to raise prices not only to protect but to increase profits”.
Paul Donovan, chief global economist at UBS, referred to this as “profit-led inflation” – companies using the cover of broad-based price increases to raise their own prices more than they have to – and more colloquially, the idea has become known as “greedflation”.
However it is labelled, if companies have been taking advantage of monopolies to raise their margins, they will be loath to lower them by much. Who wants to award themselves a pay cut right after getting a raise?
Margins are beginning to fall from their highs as companies rebalance the price-versus-volume trade-off, but they remain significantly higher than in the pre-Covid years.
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This could well continue to favour some equities. When asked what type of stock stands to benefit the most from profit-led inflation, almost three quarters of respondents opted for companies with strong pricing power.
The logic there is that until a rising backlash against monopolies or oligopolies gets properly under way, it makes sense to own the companies that can exploit the inflationary backdrop the most.
Ultimately, “greedflation’’ is not expected to lead to prolonged sticky inflation, according to a majority of survey respondents.
Only 10 per cent said it will take more than five years for the headline rate of US consumer-price inflation to return to a stable average around 2 per cent.
More than half reckon that inflation will return to 2 per cent levels within two years – in line with the market view, based on the current two-year breakeven rate of about 2.1 per cent.
So, what can be done specifically to stem profit-led inflation? The 24 per cent of survey respondents who do not believe tighter monetary policy is the answer came up with some thoughtful alternatives.
Among the frequent suggestions were better enforcement of antitrust laws around mergers, along with other efforts to stimulate more competition.
There was support for higher corporate taxes, potentially including windfall charges in areas where price-gouging is identified. “Tax them to oblivion” was one blunt recommendation.
Inflation breeds resentment by exacerbating inequality. Once pandemic savings are depleted, that resentment has the potential to mushroom, and companies’ profit honeymoon will probably face a much more challenging and regulated future.
In that case, tighter monetary policy could be the least of their worries.
