EU: Wage-earners will 'bear brunt' of inflation in 2023

"As lower energy prices continue to provide relief to households and firms' budgets, the economic expansion is expected to continue in 2023 and pick up some pace in 2024," economy commissioner Paolo Gentiloni said at a news conference on Monday, adding he was "proud that the European economy is showing such remarkable resilience."

But the onus of being resilient has predominantly been on wage-earners and the public finances which, the report notes, "have taken a large part of the brunt of high imported inflation," while "companies have generally been successful in passing on higher production costs to consumers."

Real wage loss

Despite gas prices dropping to €33 per megawatt-hour, a level not seen since December 2021, inflation for this year has been revised upwards to 5.8 percent on the back of higher prices remaining sticky in other areas of the economy.

Consumer prices (excluding energy and unprocessed food) rose by seven percent in April across the eurozone compared with a year earlier. So while the growth forecast for 2024 was raised to 1.6 percent, up from 1.5 percent, Gentiloni cautioned that inflation will continue to weigh down on people's purchasing power.

Nominal wage growth reached the historically high level of five percent in 2022, compared to a year earlier, but lagged behind the annual inflation rate of 9.2 percent resulting in a significant real loss of household income.

The commission projects further wage loss to occur in 2023, with disposable income at the end of the year projected to be 6.5 percent below 2020 levels, with only a slight increase of 0.5 percent seen in 2024.

Loss of purchasing power is higher for low-income households, who spend a larger proportion of their income on essentials, but no figures were included.

Profits driving inflation

The report confirms earlier reports by the European Central Bank that show corporations have increased their profit margins, further fuelling inflation, even while wages have fallen across the EU.

"The prevalence of cost shocks may have led to higher 'acceptance' by customers of price increases," the report notes, quoting the economist Isabella Weber who, in her recent work, brought what she describes as 'sellers-inflation' to the public consciousness. Therefore the consumers are "less likely to 'punish' a firm by switching to a competitor," the commission concludes.

In 2022, unit profits grew at a record 9.3 percent (year-on-year) in the final quarter. This increase contributed 3.2 percentage points of the 5.8 percent inflation, thus pushing up prices more than wages.

Unit profits have increased across all euro area countries and sectors but in some countries more than in others.

As shown in the graph above, businesses in countries above the line over-corrected profits against inflation more than in other countries, with Spain, Lithuania, Latvia, Luxembourg and Slovenia being notable outliers.

The commission warns that high-profit margins pose a risk to future inflation as it might lead to higher wage demands, entrenching inflation.

"Protracted distributional conflicts could delay the disinflation process," the commission warns, which could "ultimately force central banks to tighten monetary policy more."

However, interest rates, the ECB's primary inflation-fighting tool, targets wages, not profits, making its policies less effective now profits are the dominant driver of inflation while causing collateral damage to other parts of the economy.