Additional information
- Business inflation expectations cooled with those of consumers one-year out, but remain elevated. The slowdown in five-year expectations for inflation was less pronounced.
KPMG Insights on Inflation Survey – Wave 3 (Q1 2023)
Inflation expectations of business leaders remain well above consumers'
The following represents the third installment of KPMG Economics 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 remain extremely elevated, despite some easing of input costs.
The third wave of the quarterly survey was conducted February 1 to February 17, 2023. It is focused on business executives and provides a more complete assessment of the temperature of the economy than surveys of consumers alone.
Business expectations of inflation are driven by a combination of demand, supply costs, and competitive pressures, while consumer expectations are unusually sensitive to changes in grocery prices, notably the price of milk, and changes of prices at the gas pump, which are highly visible but do not encompass the full spectrum of inflation pressures.
The results of this quarter’s survey revealed several major shifts:
- Inflation expectations among business leaders are coming down quickly one year out – although they remain well above the expectations of households.
- C-suite members, who have the most power over pricing decisions, are driving the step down in inflation expectations.
- The step down in inflation expectations for one year out occurred across all industry groups.
- Inflation expectations five years out were stickier and remained elevated, despite a modest move down.
- The dispersion for inflation expectations is much greater across industry groupings five years than one year out. Some industries had an increase in their inflation expectations five years out.
- Retail was one of the outliers with an increase in inflation expectations five years out. That is a red flag for the Federal Reserve, which had expected that retail would be an anchor on inflation going forward.
- Three factors have consistently topped the list of drivers of expectations for business leaders: demand, unit labor costs and competitive pressures.
- Demand jumped back to number one on the list of factors that are affecting business executives’ expectations in Q1 2023, after slipping below supply-side shocks in Q4 2022.
Inflation expectations five years out were stickier and remained elevated.
Business Inflation Expectations
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.
- Responses from the KPMG Insights on Inflation survey remained higher than those of consumers in Q1 2023. One year out, businesses expected inflation of 5%, a full percentage point drop from Q4 2022. That is still higher than one year out consumer expectations but fell more than consumer expectations during the same period. 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. (Chart 1)
- Business expectations for inflation five years out edged down less in Q1 2023, much like those for consumers. That is a worry for the Federal Reserve, as they are concerned that expectations could become entrenched.
- Expectations are converging across C-suite executives one and five years out. (Chart 2)
We know from economic literature that expectations are influenced by educational attainment and income strata. The business leaders we surveyed had much higher educational levels and incomes than the overall population. They tend to adjust more rapidly to a favorable shift in expectations. It is too soon to tell if that is what we are seeing or if it is a more fundamental cooling in inflation expectations.
Chart 1: Business inflation expectations are coming down
One-year inflation expectations Five-year inflation expectations
Chart 1: Business inflation expectations are coming down
One-year inflation expectations Five-year inflation expectations
Q: What do you estimate the year-over-year rate of inflation, as measured by the Consumer Price Index, will be one year from today? Five years from today?
Source: KPMG Economics, KPMG Insights on Inflation (n=320), University of Michigan, Haver Analytics
Chart 2: C-suite inflation expectations keep coming down
Chart 2: C-suite inflation expectations keep coming down
Source: KPMG Economics, KPMG Insights on Inflation
Additional information
- The C-suite is driving the reduction in inflation expectations both one and five years out.
- The optimism could partially reflect higher education and income levels. Hope springs eternal among the upper crust.
Chart 3: Long-term inflation expectations are similar between C-suites and consumers
Chart 3: Long-term inflation expectations are similar between C-suites and consumers
Source: KPMG Economics, KPMG Insights on Inflation (Q1 2023), University of Michigan (February 2023), Haver Analytics
Additional information
- The improvement in five-year expectations among the C-suite and consumers is much smaller. This raised red flags for the Federal Reserve, which is more worried inflation becoming entrenched.
Drivers of Inflation
The major shifts this quarter were in professional business services, retail and health care. Five-year inflation expectations for professional business services and retail rose in the first quarter, while expectations in health care plummeted. The behavior of five year expectations in health care and retail were the exact opposite of what we saw in the fourth quarter.
- Retail trade has the lowest one-year inflation expectation of 4.8%, dropping from 5.7% in Q4 2022 and 7.0% in Q3 2022, the first quarter we did the survey; professional, scientific and technology services had the highest expectations for both one and five years out. (Chart 4)
- Demand is leading the shift in inflation expectations in Q1 2023 after slipping to second place in Q4 2022. This may reflect an easing of labor market conditions, including churn and the need to cover staffing shortages for those out sick and unable to work. The latter fell in the aggregate employment data between late 2022 and early 2023. (Chart 5)
- Environmental, Social and Governance (ESG) regulations and COVID were not very influential in determining inflation expectations. COVID-related economic uncertainties were erased in the latest Federal Open Market Committee statement as we transition from a pandemic to an endemic.
Chart 4: Inflation expectations are converging across industries
Inflation expectations by industry
Chart 4: Inflation expectations are converging across industries
Inflation expectations by industry
Source: KPMG Economics, KPMG Insights on Inflation (Q1 2023)
Additional information
- The professional, scientific, and technical services industry has the highest one year out and five year out inflation expectations.
- Expectations for inflation have fallen more consistently one year out than five-years out.
Chart 5: Demand is the leading driver shaping inflation expectations
Factors that shape the business view on inflation
Percentage of total companies who rate "influential" and "very influential"
Chart 5: Demand is the leading driver shaping inflation expectations
Factors that shape the business view on inflation
Percentage of total companies who rate "influential" and "very influential"
Q: On a scale of 1 to 5, with 1 being not applicable and 5 being very influential, how influential will each factor below be to your organization's pricing decisions over the next 12 months?
Source: KPMG Economics, KPMG Insights on Inflation (Q1 2023)
Additional information
- Consumer demand, labor and material cost inputs continued to rank the highest in determining inflation expectations.
- Consumer demand usurped unit labor costs as the larger determinant of prices in the first quarter, after slipping to the number two spot in the fourth quarter. The Federal Reserve has more sway over demand than supply factors.
- ESG initiatives and COVID uncertainty still ranked lowest in terms of their influences on inflation expectations.
Labor costs and Pass-through
- Labor costs have come down but remain elevated in Q1 2023 and continued to be driven by the upward pressure smaller firms are enduring. The gap between large and small-to-mid-sized firms has narrowed. (Chart 6)
- Smaller firms expect both higher unit labor costs and higher inflation one year out than large firms.
- The drop in expectations for unit labor costs is smaller than the drop in inflation expectations; those shifts suggest margin compression.
- Wage growth is expected to slow across all industries, except for the professional, scientific and technology services industry. (Chart 7)
- The percent of costs being passed on to consumers held at 75%. Firms with annual gross revenue below $5 billion have lowered the share of cost increases that they pass onto consumers. (Chart 8, 10)
- An outlier is retail, which showed an increase in its ability to pass along higher costs. Retailers now expect to pass through 65% of their costs, a jump from last quarter’s 50%. The increase was a surprise and suggests that the rebound in retail sales in January may have, at least temporarily, increased pricing power. (Chart 9)
- The greatest margin compression is in health care. One health care respondent said, "while we would like to pass along higher costs due to inflation, it is very difficult to do so on a reactionary basis."
Chart 6: Larger firms still see lower labor cost increases than smaller firms
Expectations in Unit Labor Costs change by company size
Chart 6: Larger firms still see lower labor cost increases than smaller firms
Expectations in Unit Labor Costs change by company size
Q: What do you estimate the average percent change in per person labor costs will be for your organization over the next 12 months?
Source: KPMG Economics, KPMG Insights on Inflation
Additional information
- Smaller businesses are more sensitive to changes in unit labor cost than larger businesses.
- Higher labor cost inputs appear to be driving small business concerns about inflation.
Chart 7: Professional services still foresee higher labor costs
Increase in Unit Labor Costs by industry over the next 12 months
Chart 7: Professional services still foresee higher labor costs
Increase in Unit Labor Costs by industry over the next 12 months
Source: KPMG Economics, KPMG Insights on Inflation
Additional information
- Professional, scientific and technology services ranked the highest in unit labor costs. This is despite announced layoffs in the tech sector, which are being quickly absorbed. Those who lose a job continue to easily get a job.
- Three industries: professional, scientific, and technical services, utilities and retail trade all expect unit labor costs to grow faster than inflation over the next 12 months. That suggests margin compression.
Chart 8: Corporate decision makers expect more costs to be passed through
Percent of costs changes to pass on to customers in the next 12 months by job duty
Chart 8: Corporate decision makers expect more costs to be passed through
Percent of costs changes to pass on to customers in the next 12 months by job duty
Q: What share of the change in your cost of production/delivery of services do you anticipate passing on to customers over the next 12 months?
Decision maker includes those who set or negotiate wages, make capital investment decisions, make staffing decisions, or make inventory or logistics decisions.
Source: KPMG Economics, KPMG Insights on Inflation
Additional information
- Businesses continue to expect to pass along 75% of the cost increases they face. The C-suite expects a higher share of costs to be passed through. Mid-to-lower-level managers expect a lower level of pass-through costs.
Chart 9: Pass-through varies widely by industry
Share of cost change to pass on to customers in the next 12 months
Chart 9: Pass-through varies widely by industry
Share of cost change to pass on to customers in the next 12 months
Source: KPMG Economics, KPMG Insights on Inflation (Q1 2023)
Additional information
- Wholesale trade has the highest rate of pass-through, with 80% of their costs being passed along into prices, the same as in the previous two quarters.
- Retailers expect the pass-through to be 65%, a jump from last quarter’s 50%. The increase in pass-through in retail was a surprise and suggests that the rebound in retail sales in January may have, at least temporarily, increased pricing power.
Chart 10: Small and medium-sized firms plan to pass through lower share of costs
Share of change in costs to pass on to customers by firm size in the next 12 months
Company size by annual gross revenue
Chart 10: Small and medium-sized firms plan to pass through lower share of costs
Share of change in costs to pass on to customers by firm size in the next 12 months
Company size by annual gross revenue
Source: KPMG Economics, KPMG Insights on Inflation
Additional information
- Firms that have an annual gross revenue below $5 billion have lowered the share of cost increases that they pass onto consumers and other businesses.
- Smaller firms are facing more margin compression than larger firms; their costs are not falling as rapidly as their expectations for inflation.
Cost Reductions
Investing in labor saving technologies continues to be ranked as the number one method to reduce costs; the percentage of firms citing that ticked up slightly. Fewer firms say they will reduce turnover to contain labor costs. The drop is consistent with the slight slowdown in quits rates in the second half of 2022. (Chart 11)
- Fewer firms expect to leverage remote work and recruit from lower cost areas to keep costs in check.
- Outsourcing personnel and onshoring remain low on the list of ways to reduce costs.
Chart 11: Companies are investing in labor-saving technology and employee retention
Percentage of total companies by labor cost control method
Chart 11: Companies are investing in labor-saving technology and employee retention
Percentage of total companies by labor cost control method
Q: Which of the following action(s) has your organization implemented or are currently considering implementing to control per person labor costs?
Source: KPMG Economics, KPMG Insights on Inflation (Q1 2023)
Additional information
- Investing in labor-saving technologies topped the list of ways to contain costs. This is consistent with the surveys of the two previous quarters.
- Fewer firms are focused on reducing labor turnover. This likely reflects some cooling of labor market conditions. Churn has slowed.
- Remote work is becoming less of a driver for employers looking to expand their talent pool and reduce costs. This matches the trend in advertisements for fully remote work, which have declined over the last year. Employers have shown more interest in in-person work than job seekers, but the gap is narrowing.
- Outsourcing personnel or services, or onshoring production are still not popular options for businesses to adopt to control labor costs.
Bottom Line
We’ve seen with this third installment of the KPMG Economics Insights on Inflation survey that inflation expectations of business executives are coming down but still remain well above those of consumers both one and five years out. This is a worrisome sign for the Federal Reserve as they are concerned about inflation expectations becoming more entrenched. Check in with us in late-May to see how that dynamic continues to unfold. Insights from our KPMG clients’ and other business leaders’ opinions and actions help shape the outcomes in this inflationary world, something not experienced for forty years.
Explore more
Meet our team
Diane C. Swonk
Chief Economist, KPMG US
Diane C. Swonk
Chief Economist, KPMG US
Subscribe to insights from KPMG Economics
KPMG Economics distributes a wide selection of insight and analysis to help businesses make informed decisions.