Germany: Profit squeeze tempers price risks – ING

ING economists Carsten Brzeski and Franziska Biehl contend that while German inflation is anticipated to exceed 3% and remain high until the end of the year, a repetition of the 2022 inflation surge of double-digit rates is improbable. Weak demand, a less robust labor market, and depleted pandemic savings are reducing pricing power, compelling companies to absorb cost pressures by reducing profits instead of transferring them to consumers.

Although inflation is projected to rise further over the next few months, potentially surpassing 3% and staying elevated until year-end, a resurgence of 2022-level inflation still seems improbable. Some downstream effects from energy costs on other goods are expected, though they have not yet materialized. Yet, the circumstances that enabled inflation to become a widespread issue four years ago are no longer present.

The labor market has softened, making substantial wage increases less of a priority than job security. Additionally, pandemic savings have been exhausted. Consequently, consumers' ability and willingness to pay higher prices are significantly lower compared to pre-pandemic times. Consequently, companies appear to face constraints on their pricing power, a situation markedly different from the one observed in 2022.

While pricing power may still exist upstream in the production chain, it gradually diminishes before reaching the consumer. This yields two crucial insights: (i) the transmission of higher energy prices to final consumption, and consequently inflation, remains uncertain; and (ii) if the consumer is not bearing the cost, someone else will have to.

Even if the inflation outlook becomes more precarious in the coming months, the dynamics differ fundamentally from those witnessed during the last energy crisis. Back then, profits were widely regarded as part of the inflation problem, leading to terms like "greedflation" and "shrinkflation." This time, it appears that profits, or more efficient profit-squeezing, will mitigate, rather than exacerbate, inflationary pressures.

The conflict in the Middle East and surging energy prices have boosted headline inflation across the eurozone. However, in Germany, the impact was temporary, as the government's two-month fuel tax rebate helped temper the price increase. In August, inflation stood at 2.9%, which is roughly one percentage point higher than in February but still far from the double-digit rates seen during the 2022 energy crisis.