By Bas van Geffen, Senior Macro Strategist at Rabobank
Markets mostly seemed to shrug off the events in Russia of last weekend. However, CBOT Wheat futures extended their climb to a four-month high. The active contract has increased 25% month-to-date, which would be the second-largest monthly increase in a decade. The grain’s gains were partly weather-related, but the unrest caused by the Wagner revolt provided more momentum. There doesn’t appear to be any immediate disruption to Russia’s wheat trade, but the shipping industry will certainly reassess the risks of operating in the region. Moreover, the domestic turmoil may make Putin less inclined to sit down and negotiate the extension of the grain deal that allows the export of Ukrainian crop through Black Sea ports. Without a renewal, the deal expires mid-July. And the UN already expressed concerns that the Black Sea grain deal may not be renewed prior to this week’s events.
The fresh highs for wheat add to the inflationary pressure that was still present in food inflation, with earlier shocks still being transmitted through the food production chain. That’s particularly bad news for low income households, for whom food is a significantly larger portion of the consumption basket.
The good news is that the original cost shocks appear to be fading. Particularly upstream manufacturers are expecting to moderate their selling prices, which should be passed on through the supply chain. That would be the bullwhip effect in reverse. Yet, the risk remains that the original terms of trade shock sparks another type of inflation, simply because no rational actor wants to bear the brunt of it: we’ve been saying for some time now that attempts by employers and employees to get compensation for the cost increases will make inflation very sticky on the way down.
The IMF has joined those who conclude that corporate profit margins have been a key driver of inflation in Europe: “Rising corporate profits account for almost half the increase in Europe’s inflation over the past two years as companies increased prices by more than spiking costs of imported energy.“ The authors stress that this doesn’t mean that profitability has actually increased, but they do conclude that businesses have so far been able to shield themselves better from the negative terms-of-trade shock that hit the continent than workers. For central banks, the big question remains to what extent labor will now catch up and how much that will eat into corporates’ margins. As the IMF authors conclude, “now that workers are pushing for pay rises to recoup lost purchasing power, companies may have to accept a smaller profit share if inflation is to remain on track to reach the European Central Bank’s 2-percent target in 2025.”
A further push for pay rises certainly isn’t reflected in Germany’s minimum wages, though. The country’s Minimum Wage Committee has recommended to increase the minimum wage to €12.41 in 2024, and €12.82 in 2025. That’s a moderation to about 3.3% annually in the next two years, after the government decided to bump the minimum pay from €10.45 to the current €12/hour last October. Yet, even that 3.3% rate, if structural, is still somewhat on the high end of the rate of pay growth that is consistent with the ECB’s 2% inflation target.
Speaking of which, the European monetary policymakers and their guests have flocked to Sintra, Portugal for the annual ECB Forum on Central Banking. Unsurprisingly, inflation makes for a big part of this year’s agenda.
Supporting the abovementioned reverse bullwhip, data continue to flag a weakening growth outlook, particularly for the manufacturing sector. Yesterday’s Ifo business survey reported a substantial further decrease in respondents’ expectations, thwarting hopes that the German economy may stage a strong recovery from the recession in the previous two quarters. To the extent that this reflects lower demand for goods, and therefore lower pricing power, the weak growth may be a small welcome sign.
