Eurozone businesses have come in for plenty of criticism over recent years for fattening up their margins. The supply disruption caused by the Covid-19 pandemic, followed by a surge in energy prices, provided some cover to raise prices and boost their profits. The International Monetary Fund calculated that close to half of the hike in consumer prices in the Eurozone since early 2022 had stemmed from a growth in the bottom line of the region’s companies. Unions complained of ‘greedflation’ and even the European Central Bank said it was monitoring for potential price gouging of consumers.
For many financial officers – tasked with maximising shareholder returns – such language may sound overly harsh. It also seems that profits are gravitating back to more normal levels.
Part of the reason margins have been contracting has been a recent acceleration in wage growth, as workers seek to recoup spending power lost during the recent surge in inflation. WSI, a trade union think tank, is now forecasting that negotiated wages in Germany will jump by 5.6% in 2024 – the most rapid increase in real terms since it started collecting data in 2000.
‘Wage settlements are backward looking and reflect efforts by unions to catch up with a higher cost of living’
Austria’s central bank governor, Robert Holzmann, has warned that such swift increases in compensation could deal a blow to the competitivness of the regions’s firms. Meanwhile, IG Metall, Germany’s largest trade union, is pressing for a 7% pay increase for 3.9 million workers in the metal and electrical sectors.
Cause for alarm?
So how worried should CFOs be and is there anything they can do to maintain margins at current healthy levels?
First, it is worth observing that wage settlements do appear to be coming under control. The latest data from the ECB showed negotiated settlements – which cover about 80% of the region’s workers – had averaged 3.6% between April and June 2024, the slowest pace since the end of 2022. This was also down from 4.7% in the first three months of the year.
This deceleration looks likely to continue, argues Andrew Kenningham, chief European economist at Capital Economics. ‘These wage settlements are backward looking and reflect efforts by unions to catch up with a higher cost of living over recent years,’ he says. ‘When pay negotiations resume next year, they will be taking place against the backdrop of inflation that has been back to around 2%. Therefore, it looks unlikely that the next round of pay settlements will be so alarmingly high.’
The position of companies should also be strengthed by signs that competition for workers appears to be cooling – albeit from elevated levels. While unemployment is close to all-time lows and has been on a downward trend for over a decade, job vacancies have been falling (see Eurostat chart below).
‘Overall, the pace of growth in the eurozone looks set to pick up from current sluggish levels, especially in Germany’
A second source of reassurance is that profit margins will be declining from exceptionally high levels. Gross operating profits climbed to a peak of 42% of total gross income for the Eurozone economy in the fourth quarter of 2022, well above the average of just over 40% between 2018 and 2019, prior to the pandemic. ‘It has since dropped back to 40.7% and is likely to fall further in the coming quarters,’ says Kenningham. ‘However, we are looking at a return closer to a historic norm, rather than a slump.”
And thirdly, other headwinds for business look set to fade. ‘Overall, the pace of growth in the eurozone looks set to pick up from current sluggish levels, especially in Germany,’ says Léo Barincou, a senior economist at Oxford Economics in Paris and a former French Treasury official. ‘That should help margins stabilise into the second half of 2025.’
Cost of capital
Companies should benefit from a falling cost of capital as the European Central Bank continues to cut rates. After easing policy for a second time for 2024 at its September meeting, the ECB is widely expected to lower rates once more before the end of the year, followed by around three more in 2025. Elevated prices for energy and industrial metals – such as copper and aluminum – are also becoming less of a drag on profits.
That said, no self-respecting financial officer is likely to tamely accept the erosion of margins – even if that is from artificially inflated levels. There are various options that might help slow this process.
‘While there is not much that individual companies can do about the supply of labour, current pressures provide a good reminder of the importance of good corporate house-keeping,’ says Kenningham. ‘Starting with staffing levels, this might include efforts to deploy employees more efficiently or offer more work incentives in lieu of heftier pay increases.’ This can include more fleixble work, such as remote working or shorter weeks.
‘With a high cost of credit, it is not surprising that business investment has been weak’
Austria’s central bank governor Holzmann has also argued that recent wage rises should encourage businesses ‘to invest in productivity-increasing ventures’. This has been easier said than done at a time when borrowing costs have been at their highest levels since the creation of the euro in 1999.
Artificial intelligence
‘With the high cost of credit, it is not surprising that business investment has been weak, slowing in the first half of 2024,’ says Barincou. But note that the interest rate environment is improving. And recent advances in artificial intelligence (AI) should also give companies a wider range of technologies that can help boost worker productivity and cut waste. That can range from software to assist with more mundane tasks, including in accounting and finance, to systems aimed at lowering other costs. Germany’s Aedifion, for example, is using AI to help companies monitor every aspect of energy consumption for offices and factories, driving down bills by an average of 20%, the company says.
The bottom line for companies is that a period of leaner margins probably lies ahead in the coming quarters. But any squeeze below the historic average is unlikely to last for long, as interest rates fall, growth picks up, and wage demands moderate. Far-sighted CFOs also have various options to offset part of the pressure from more generous pay deals.
More information
ACCA’s annual conference, Accounting for the Future, features a session on the global economy 2025. Register to watch live on 26-28 November or on demand. Up to 21 units of CPD are available.
