Lagarde pledges ECB action if both profits and wages rise

European Central Bank President Christine Lagarde said Friday the bank will not “stand idly by” if there is a simultaneous increase in profits and wages given persistently high inflation in the region.

The euro zone has been battling high inflation for around a year given firstly, record-high energy costs, and more recently, soaring food prices.

Headline inflation has slipped in recent months, dropping to 5.5% in June from 6.1% in May, according to preliminary data. Nonetheless, it remains well above the ECB’s target of 2% and the central bank does not expect it to fall to target before 2026.

As such, the ECB is vigilant about any risks that could reverse the trend and drive inflation up further, including profit margins.

“The recent period of high inflation was not accompanied by a reduction in firms’ profit margins, which even increased in some cases, particularly when demand for goods and services outstripped supply. At the same time, wages have also risen by more than expected,” Lagarde said in an interview with French newspaper La Provence.

There are concerns that some companies are increasing their prices more than is needed to compensate for higher costs, thereby boosting their profit margins — and potentially inflation — in the process. In addition, workers, who are also facing higher prices when purchasing goods, will be pushing for more wage increases.

Lagarde said it was important to know whether companies plan to reduce their margins, “which is what has normally happened during previous high inflation episodes, or whether we are going to see a twofold increase, in margins and in wages.”

“A simultaneous increase in both would fuel inflation risks, and we would not stand idly by in the face of such risks,” Lagarde added.

Central banks have been paying increasing attention to this issue amid fears that companies are taking advantage of higher prices and fueling inflationary pressures further. Data from the International Monetary Fund showed in June that half of the increase in European inflation over the last two years was due to higher corporate profits.

At the time, the IMF warned that companies may have to accept smaller profits to bring inflation back on track.

Speaking at a press conference in June, Lagarde said her team will “take harder monetary policy measures” to ensure that there are no further inflationary pressures from businesses’ profits.

“You really asked me specifically the question of whether corporations and labor — and I’m using that term in a generic, comprehensive way — will find the terms under which they don’t contribute to fueling even more inflation that would call on us to take harder monetary policy measures. This is the assumption that we make,” she said last month.

“I think economically it is justifiable, it is rational, but of course humans are humans. It’s going to be for the parties around the table to actually determine what they do going forward in terms of allocating profits and organizing these social relationships. What they can be certain of in their discussion is that the European Central Bank will take all necessary measures to return inflation to 2%.”