Where next for food price inflation?

 (ES Composte)
(ES Composte)

Last year we predicted food inflation would peak at approximately 19%. This raised eyebrows, but the prediction was proved right as inflation outcomes have, broadly, followed the path we predicted. And while we see some improvement ahead, consumers may not be seeing that on supermarket shelves for a little while yet.

Unfortunately, a very rapid run-down of inflation or, indeed, a reverse of inflation isn’t going to happen any time soon in our view. In fact, we predict that while food inflation will come down, it is likely to stay sticky - above 10% - for most of this year.

The rise in food prices in recent months has felt like such a shock for UK consumers, partly because the UK grocery market is one of the most competitive and dynamic in the world. It is a fiercely contested arena where major players constantly vie for market share and customer loyalty. With a strong emphasis on convenience, value and product quality, supermarkets and manufacturers in the UK engage in intense competition to attract and retain customers. The UK’s strong track record, especially over the last 20 years, has meant that the UK consumer has had some of the best grocery deals in comparison to other European countries.

Now, the powerful forces which drove price increases in recent months are starting to run out of momentum.

Prices for energy, fertiliser and some – not all – basic food commodities are falling, posing the question: when will customers start seeing these falls in the prices they pay?

The competitive nature between grocers means that they are incentivised to pass on savings to customers as soon as possible, and we are already seeing some evidence of this on the supermarket shelves. In April and May, several supermarkets delivered price cuts for milk, bread and butter.

There are of course many variables  in play, with weather and crop yields always hard to predict, but – barring major new shocks – IGD believes that food price inflation has now peaked and will begin to slow as 2023 progresses.

Lower inflation does not mean we are on track to see deflation and lower prices anytime soon.

First, not all foods have yet seen reductions in production cost or wholesale prices. For example, whilst the cost of producing milk has fallen slightly, costs for eggs remain very high.

Second, previous cost changes have not yet been passed on through the supply chain in full. Businesses at every level, from farms onwards, say they are still having to absorb high costs and squeezed profit margins. Even the largest businesses are affected. Leading supermarkets have seen profits fall in the last year, even though prices for shoppers have risen. This “margin compression” has sheltered shoppers from some of the impact of inflation., But in the longer term it will be limiting the businesses’ ability to invest for the future, including the ability to prepare for climate change.

Third, supply chains for many grocery products are long and complex. Production and delivery of a ready meal, or a pizza, may involve dozens of businesses and many stages. It therefore takes a long time for cost change at one end of a supply chain – a farm – to filter down to shoppers at the other end.

Finally, production of food and drink cannot be expanded readily in response to higher prices. Essential resources such as soil, water and labour are in limited supply. Some products can only be prepared at certain times of year and can take months or years before being ready for market. In short, we cannot immediately increase the number of chicken farms to help tackle the continued high cost of eggs.

What all this means is that the anticipated fall in the cost of a shopping basket is likely to be a slow process, running behind falls in the cost of other essential items such as motor fuel and utilities.

With prices stabilised, we believe that grocery businesses will seek to deliver reductions, wherever possible, as they have done during previous periods of high inflation.

Ultimately, price is a powerful driver of choice, causing shoppers to switch between retailers or products. Grocery businesses know they can’t afford to be an outlier in pricing as inflation falls kick in.

James Walton is Chief Economist, IGD