The inflexibility of prices in a range of products and services, both in the Eurozone and the United States, appears to temporarily postpone the completion of the interest rates’ upward cycle and the onset of their downward cycle, as evidenced by the meetings held by the European Central Bank and the Federal Reserve this week.

The main reason is common for both central banks: structural inflation, which excludes the volatile prices of energy and food, and therefore serves as a better indicator for monetary policy, decreases much less than the expectations of monetary authorities.

In the United States, structural inflation peaked at 6.3% last September and only declined by one percentage point to 5.3% in the 8-month period until May, while the general index decreased from the high of 9.1% in June of the previous year to 4% last month. On Wednesday, the Fed's Chairman, Jerome Powell, justified the central bank's decision to leave the benchmark interest rate unchanged but signaled a possible further increase by half a percentage point to 5.6% by the end of 2023.

In the Eurozone, structural inflation steadily increased until March, and in April-May it decreased by four tenths of a percentage point, specifically to 5.3% on an annual basis, while the general inflation peaked at 10.6% last October and decreased to 6.1% in May, mainly due to a decrease in energy prices.

On Thursday, as expected, the ECB increased its key interest rates by a quarter of a percentage point, with the deposit rate set at 3.5%. Its President, Christine Lagarde, announced a corresponding increase in July and did not rule out another such move in September. Lagarde referred to disappointing prospects for structural inflation as the ECB officials' new forecast is revised upward to 5.1% for 2023, compared to 4.6% three months ago.

However, why are prices not tapering as predicted? The explanation seems to be generally common on both sides of the Atlantic: economic activity and the labor market are much more resilient to interest rate increases, thus maintaining a level of aggregate demand that is incompatible with faster inflation reduction.

In the United States, the forecast of Fed officials for GDP growth this year was revised upward to 1% from just 0.4% in March, while the forecast for unemployment was lowered to 4.1% by year-end from 4.5% in March, as businesses continue to hire and overall employment increases. With such data, there is no significant decrease in demand that would allow for price reduction. On the contrary, many businesses are facilitated in implementing a policy of increasing their prices at a rate faster than the increase in their operating costs, including wage hikes.

Given the significant decrease in energy prices and other financial commodities this year, with the ECB projecting an average decrease of 11.5% in non-energy commodities, it becomes apparent that many businesses are capitalizing on the prevailing inflationary environment to widen their profit margins. This ability of businesses to increase their profit margins also sheds light on why they are not reducing their workforce.

A similar scenario unfolds in the Eurozone, where unemployment rates are reaching historically low levels. The projection for 2023 anticipates a 6.5% unemployment rate, slightly lower than the ECB's previous forecast of 6.6% in March. Additionally, employment is expected to grow by 1.3%, surpassing the earlier forecast of 0.8%. Lagarde highlighted the upward inflation risks attributed to anticipated wage hikes aimed at offsetting the erosion of purchasing power. Moreover, the Eurozone is witnessing a rise in profit margins among businesses.