The latest ONS inflation figures show that food and non-alcoholic beverage prices have increased by 5.9% year on year in March 2022. This continues the trend from January, when sector inflation stood at 4.3% and March’s F&B inflation out-turn is the highest since May 2011. This stands in marked contrast with the previously stable level of F&B price inflation; for example, there was no increase in average F&B inflation between October 2020-September 2021.
Food and beverage are, of course, just a subset of more general inflation drivers and concerns, accounting for 9.3% of the overall consumer shopping basket. Economy-wide inflation in March 2022 was 5.5%, the highest since 1992. Recent forecasts from the Office for Budget Responsibility (OBR) expect economy-wide inflation to peak at just under 9% in Q4 2022. These OBR forecasts only expect inflation to return below the Bank of England target rate of 2% in Q3 2024, highlighting the fact that consumers are in for a rough ride over the next 12-18 months.
OBR economy-wide inflation expectations (%)
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Whilst the dynamics of contracts and high levels of competition have meant that inflation in the F&B sector is slightly lower than the economy as a whole (5.9% compared to 6.2%), these constraints on prices are unlikely to last. The sector is particularly exposed to current economic and political instability affecting global supply chains, and production and labour costs can expect higher inflationary pressures over a longer period than for other goods.
Concerns over inflation have, of course, increased considerably following the terrible events in Ukraine. Approximately 20% of forecast inflation is due to the war in Ukraine, and the F&B sector is likely to follow a similar (or potentially more challenging) path.
What's driving inflation in the F&B sector?
1 Government spending and global supply chains
The most benign version of the drivers of inflation is pandemic-related. Following the COVID-19 pandemic, inflation has been impacted by government spending (effectively boosting the money supply and more broadly, spending to support firms and workers), and a period where the interconnectivity and interdependence of global supply chains have been stretched.
Whilst the first of these points holds across the economy, food and beverage supply chains raise specific concerns. The latest Food Security Report (updated December 2021) shows that the UK imported approximately 46% of the food it consumed in 2020. Food imports, especially in vital categories such as fruits and vegetables, are very important for food consumption in the country. The supply chain bottlenecks and disruptions due to the pandemic have increased the costs of imports and have significantly contributed to the observed price rises.
Nevertheless, if the drivers of inflation were limited to these factors, then inflationary impacts in the F&B sector would be transitory and after a matter of months of trading, prices could have returned to previous levels.
2 Labour shortages
For the UK, supply chain bottlenecks have clearly been exacerbated by labour shortages, which provide a potential longer-term driver of inflation. While the most commonly cited example is the significant reduction of HGV drivers following Brexit, the problem is more widespread and profound.
ONS data shows the F&B sector’s reliance on EU migration. Around 10% of agriculture, food and drink manufacturing, food wholesaling and food retailing workers came from the EU27 member states and 32% of employment in food and drink manufacturing. Alongside this, the UK domestic labour market is in a very healthy state with unemployment already at low pre-crisis levels, severely limiting alternative sources of labour at current wage levels unless wider visas are issued.
3 War in Ukraine
Alongside these issues for supply chains, the Ukrainian conflict will inevitably create further challenges within the global commodities markets as supply is disrupted in a number of key commodities. In many cases, the impacts on the UK food and beverage directly are relatively limited in the short term due to trade patterns, but an increase in global prices will lead to price inflation in the medium term. For example, Russia and Ukraine combined were responsible for 28% of global wheat exports in 2021, and while the UK currently domestically provides 90% of its own wheat, prices for export are increasing rapidly and hence domestic prices will inevitably adjust.
Similar patterns are also being experienced in a number of commodities, particularly metals and chemicals used within the F&B supply chain. Economic sanctions are expected to dramatically limit exports in sectors where Russia has a higher market share of exports, and forward-looking prices have peaked at over 100% higher than that seen prior to the conflict. It seems inevitable that the conflict will further expose the challenges to the interconnected global food and beverage supply chains that have suffered across the pandemic.
4 Present and future energy prices
The other key inflationary driver impacting the F&B sector is, of course, energy prices, as they drive up the costs of food production, storage, and distribution. Energy is in high demand throughout the whole supply chain: from the fuel needed to operate the agricultural machinery to the electricity required to operate refrigerators and freezers for storing food; to the fuel needed to distribute the food. Alongside this, higher energy costs are also driving up household costs and hence a driver for wage inflation within the economy.
Even prior to the Ukrainian conflict energy prices were already being driven upwards through a combination of political instability, weather and market-based issues. For example, the OBR expectations for gas prices more than doubled and for oil increased by 30% between October 2021 and prior to the war in Ukraine. However, following the invasion of Ukraine, current and, more importantly, futures prices of energy have rapidly increased as market makers have considered the effects of present and likely potential future sanctions imposed on Russia.
The most immediate impact has been felt on gas prices. While the UK is not directly reliant on Russian gas, again it is interconnected to the global and European wholesale market. The nature of gas is such that it is extremely difficult (and where possible costly) to change supply and so consequently, we have seen prices increase significantly. Further, European governments have mostly chosen to forsake Russian gas.
The price of oil also increased significantly before partially falling back. While the nature of the oil market does allow for greater point-to-point replacement of Russian exports in a shorter time, such turbulence will likely continue to place pressures on international prices higher for an extended period.
Where does this all take us? How long will high inflation last?
The next 12 months seem to have general price inflation in the region of seven per cent, with peaks of nearer 10% due to the current conflict built-in. There is little reason to expect the UK food and beverage sector to be immune from this. Indeed, the nature of the shocks facing supply chains at present may mean that this inflationary period lasts longer, perhaps an 18-month time period, and has a longer-term impact on the sector relative to others. Key to the path for inflation in the F&B sector and inflation more generally will be whether inflation expectations become entrenched. This is important because it can reinforce inflationary pressures are baked into expectations and lead to further inflationary pressures through higher wages as workers seek to protect real incomes.
For more information, contact Chris Williams.
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