Reserve Bank analysis finds businesses worried about price pressures

The Reserve Bank says the country’s largest companies are more concerned about pricing pressures than at any stage in the past 16 years.

The Reserve Bank says the country’s largest companies are more concerned about pricing pressures than at any stage in the past 16 years as they combat economic headwinds stemming from rapid interest rate rises and multi-decade high inflation.

A report titled Firms’ Price-setting Behaviour: Insights from Earnings Calls, published by the RBA on Monday, shows that businesses are more likely to react to increasing input costs compared to decreasing input costs, suggesting that rising prices are likely to remain front of mind for company executives even as supply pressures moderate.

The report noted that pricing pressures were front of mind of listed companies over the past 18 months – coming in substantially higher than historical averages stretching back to 2007. The analysis by the RBA saw researchers collate 700,000 paragraphs of text from 5500 earnings call transcripts since the start of 2007.

Researchers at the central bank used a large language model to group paragraphs within the transcripts into categories related to input costs (including labour costs), demand, prices and supply shortages, and the tone of these discussions are used to construct sentiment indicators.

Final price sentiment was found to have a stronger association with input costs compared to sentiment about demand. The authors said that this connection was consistent with survey-based findings that the predominant pricing strategy of firms is to set prices as a mark-up over costs.

RBA researchers Callan Windsor and Max Zang said discussions around final prices by companies had become more sensitive to import costs but less sensitive to labour costs in the period since 2021.

“Our results are consistent with firms using pricing strategies that focus on a mark-up over costs. They are also consistent with firms being more reactive to rising, rather than falling, input costs,” the authors said. “These experimental findings appear to indicate that aggregate price-setting behaviour could depend on the source of the shocks firms face (demand or cost driven), the direction of the shock (with firms reacting more to cost increases relative to decreases), and which industries are most affected.”

The recent earnings season saw margins at many companies shrink in the past year as a result of higher costs and more difficultly in passing on costs due to consumer tightening their belts as a result of 400 basis points worth of rate hikes by the RBA and other cost-of-living headwinds.

Analysis of earnings calls suggest that pricing behaviour differs significantly across industries, after controlling for shocks to prices that are common to all firms within an industry. Cost-focused strategies appear more important for the consumer staples, utilities, materials and industrial sectors.

Demand-focused strategies also appear important for the materials industry and to a lesser extent the real estate, consumer discretionary, financial and health care sectors.

The report said that the difference between consumer staples and discretionary sectors was that price elasticity of demand for consumer staples is typically considered to be low while discretionary tended be higher.

“The substantial heterogeneity by industry in these estimates illustrates that the macroeconomic impact of aggregate shocks crucially depends on which industries are particularly affected by them,” the authors said.

The report concluded that sentiment on company calls since 2007 mirrored the views on purchase costs, forward orders, selling prices and labour costs by the RBA’s business liaison program and NAB’s monthly business confidence report.

The cost of living for employee households jumped 9.6 per cent higher in the year to June, the highest since records began in 1999, versus 6 per cent growth in the widely quoted consumer price index, which does not include mortgage interest payments.

The 92 per cent increase in mortgage interest charges for employee households was up from a 79 per cent lift in March, which the Bureau of Statistics said reflected rate rises and the expiry of fixed-rate mort­gages in the quarter.