“Pricing Power” for All – Why Central Banks Are Caught off Guard by Soaring Inflation
This troubling situation will be exciting to follow in the months to come.
Inflation reached 7.5% in America in January 2022. This is a forty-year high. And we won’t have a quick reversal of this trend. All investors are now looking to identify companies that can ride the wave of extremely high inflation in the coming months.
Companies with “pricing power”, i.e. the power to pass on the price increases they are experiencing to their customers, are the ones to favor. The search is proving to be quick, as there are a limited number of such companies.
However, the current crisis is unlike any other. Something amazing is happening.
As you probably know by now, companies are faced with soaring raw material costs, soaring labor costs, soaring transportation costs, and bottlenecks everywhere. In normal times, this situation penalizes the vast majority of companies that have to absorb part of these increases, as they cannot pass them on in full to their customers and consumers.
Except for the rare companies that have this famous pricing power.
You know these companies. For example, there are luxury companies: buyers of Hermès bags will not buy fewer bags if Hermès raises its prices by 10%. The price of the iPhone is already exorbitant, but if Apple decides to increase its price by 15%, sales will likely remain the same, or even more surprisingly, they will increase. Walt Disney is also often cited as a company with pricing power, not to mention tech giants like Google and Microsoft. Generally, the vast majority of Tech leaders have this pricing power.
But this time, something seems different.
You probably also noticed that the number of companies posting record profits is at an all-time high. Given the soaring costs and inflation, this situation seems abnormal.
The situation is so normal that some companies, such as TotalEnergies in France, feel obliged to hand out 100 euro cheques so that no one notices that they are taking advantage of soaring oil prices to make record profits, 16 billion euros for the French oil giant.
With this crisis, an astonishing fact becomes apparent: the vast majority of companies have passed on the increase in costs they are experiencing to consumers. Not part of the increase, but the whole increase, and in some cases even more. Even companies that don't usually have pricing power have decided to use it.
The explanation behind this new phenomenon is to be found in the monstrous savings accumulated by consumers since the beginning of this crisis, but also in the fact that they want to make up for lost consumption so much that they are willing to pay any price to get what they want here and now. Consumers have not suffered a drop in purchasing power, so they can afford their whims.
The consequence of all this is a surge in consumer prices that is much higher than expected. This then explains why central banks are caught off guard. These institutions thought that companies would not be able to pass on price increases to consumers and that inflation would therefore be moderate.
But not only are businesses passing on the price increases, but they are also amplifying them, causing inflation to spiral out of control. This is a troubling phenomenon, but one that will be exciting to watch in the months to come, as central banks will have to find the right monetary policy responses to prevent the situation from getting out of hand.
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