KPMG Insights on Inflation Survey – Wave 2 (Q3 2022)
Inflation expectations of business executives
Inflation has become global in scope and is the primary target of central banks both at home and abroad. Stagflation, a term last used in the 1970s in the U.S., is already occurring in some developed and developing economies.
Businesses play a pivotal role in how wages and prices are set and how they plan to mitigate any margin compression associated with those shifts. Understanding their views on the persistence of inflationary pressures provides a window into the trajectory of economy-wide price pressures in the years ahead. A breakdown by industry reveals the differences being felt across key sectors of the economy.
KPMG Economics launched “Insights on Inflation,” a multiyear survey of KPMG clients and other business leaders to understand their responses to the inflationary environment we are now enduring. Our survey findings suggest that inflationary pressures may be higher for longer than consumers are currently expecting.
The first wave of the quarterly survey was conducted August 9 to September 6. It is focused on businesses and provides a more all-encompassing measure of the temperature of the economy than surveys of consumers.
This first survey only represents a snapshot of what businesses are thinking.
Businesses, which have larger influences over both the wages they pay and the prices they charge, see inflation persisting for longer than consumers.
Diane Swonk
Chief Economist
We focused on four main areas:
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Inflation expectations of KPMG clients and business leaders
Business expectations of inflation are driven by a combination of demand, labor costs, and competitive pressures, while consumer expectations are skewed to respond to prices at the gas pump, which are highly visible but do not encompass the full spectrum of inflation pressures.
We compared the inflation expectations of business respondents in our survey with the same expectations of consumers from the University of Michigan Surveys of Consumers. Businesses expect much higher inflation one and five years out versus consumers. Responses of those with direct control of wage, staffing, capital outlay, and inventory decisions were in line with the overall business responses from the KPMG Insights on Inflation survey. That is still well above expectations by consumers.
Businesses expect higher rates of inflation than consumers
Comparison of median inflation expectations in two surveys
Consumer vs business inflation expectations
CEOs, which have the largest influence over wage and price decisions, expect much more inflation than those which are further down the corporate hierarchy. CEOs estimated that inflation would hit 7.4% one year out and slow to 4% five years out. That is 60% more inflation than consumers expect one year out and more than 40% five years out.
CEOs are expecting much higher inflation rates than consumers
Comparison of inflation expectations across two surveys
Expectations by industry: Retail trade has the highest expectations for inflation one year out at 7.0%; manufacturing has one of the lowest one year out at 5.6%. There is less variation by industry five years out. The exception is professional business services, which expects the highest inflation rate of 5% five years out. Industries are grouped via the North American Industry Classification System (NAICS), the standard used by the Federal statistical agencies.
Inflation expectations vary by industry
Year-over-year inflation expectations by industry
The most important categories in shaping respondents' views about inflation were consumer demand and unit labor costs. ESG initiatives and COVID uncertainty ranked lowest in terms of their influence on inflation expectations. That is notable, given the surge in staffing shortages and escalating costs associated with higher infection rates due to COVID and the growing ranks of workers struggling with long COVID.
Consumer demand is ranked first in shaping inflation expectations
Percentage of total companies who rate the following factors as "influential" and "very influential"
What are the expectations related to labor costs?
Overall businesses believe that their per person labor costs will increase by 6.0% in the next year, the same as their inflation expectations. Larger firms expect to see lower labor cost increases as compared to smaller firms. Ultra-low interest rates consolidated market power among larger, tech-savvy firms, which set wages for the broader economy. Those firms set the floor for wages as the economy reopened. Our own analysis suggests that wage costs need to slow to almost half that pace to bring inflation down to the Federal Reserve’s 2% target.
Larger firms expect to see lower labor cost increases
Expectation in Unit Labor Costs change by company size
Respondents from professional business services expect a 7% acceleration in labor costs next year, the fastest of any industry. Manufacturing, finance and insurance were tied for the lowest expectations for labor cost growth at about 5%. The skew toward professional business services is important as it suggest we could see higher, more persistent inflation in the service sector.
Professional services and health care industries expect higher labor costs
Increase in Unit Labor Costs by industry over the next 12 months
What is the percent of inflation-driven cost increases that will be passed through?
The C-suite plans to pass on 80% of higher costs in the prices it charges. Respondents who do not have any input to key management decisions only believed 63% of costs would be passed along in prices.
C-suite members expect higher share of costs to be passed through
Percentage of costs changes to pass on to customers in the next 12 months by job title
The pass-through of costs was especially high in manufacturing and wholesale trade. The pass-through rate is high and assumes that there will not be a lot of push-back by consumers. If they are wrong, margins could narrow much more rapidly.
Pass-through by industry
Share of cost change to pass on to customers by selected industries in the next 12 months
Small businesses planned to pass along more in prices than larger firms. That likely reflects the larger margins and scale of large firms, which allow them to absorb a larger share of escalating costs. Large firms have a larger influence over competitive pressures, which means they lead instead of following market trends. Large firms may have more room to respond to the backlash by consumers to higher prices than small firms. This is something the Federal Reserve is watching.
Smaller firms see higher share of costs to be passed through
Share of change in cost to pass on to customers by firm size in the next 12 months
What cost savings strategies are businesses considering to combat inflation?
Investing in labor-saving technologies was cited as a means to contain costs for a whopping 78% of respondents; some 68% of firms planned to reduce labor turnover, a sign they believe the labor market may be cooling, and a slight majority—53%—plan to recruit from lower cost areas and allow work-from-home to deepen their talent pools. The breadth of ways in which businesses are looking to contain costs reveals the concerns they have for profit margins going forward. As noted above, those concerns are more acute for small than large firms.
How are companies planning to reduce unit labor costs?
Conclusion:
Businesses, which have a larger influence over both the wages they pay and the prices they charge, see inflation persisting for longer than consumers do. Future surveys will shed light as to how quickly rate hikes by the Federal Reserve are shifting those expectations and whether the inflation we are experiencing is become more self-feeding or inertial. Future surveys will provide valuable insights into how firms are dealing with the costs pressures they are enduring and how those effects are playing out by industry. We will be looking for industries where margin compression is the greatest and the least. That will provide a road map on how well industries are provisioned to weather the current inflation storm now and any more that may arise as the global economy fragments.
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