Brexit has wide reaching implications for the UK food industry.
I am a Lead Retail Analyst at Verdict, and I work mainly on the UK Food & Grocery market, alongside working as part...
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More complex in nature than non-food markets, grocery in the UK is set for an uncertain future and one that will be impacted by direct and indirect policy once the UK starts its complicated emancipation from the EU. From the significant loss in value of the pound, to the implications of free trade, freedom of movement and agricultural subsidies, retailers must brace themselves, and prepare consumers for price rises after a period of subdued profitability.
While consumers have enjoyed next to no inflation, and even deflation in some categories over the past two years as the grocers waged a bloody price war, even reduced input costs have not been enough to mitigate the impact on retailer margins. Average operating margin across the Big Four and Co-op has dropped from 4.8% in 2011 to just 2.1% in 2015.
Retailers have been paying for low prices over the past five years with margin, chasing each other and the discounters in a bid to woo shoppers. What does this have to do with Britain leaving the EU? Well in the face of inevitable cost inflation, the grocers now have very little option but to raise prices for consumers.
Price pressure delayed, but inevitable
In the short term, the falls we have seen in the value of sterling will be a concern for the grocers. While the approach into the summer months will delay any sharp increases in price, with increased domestic production and retailers hedged with international suppliers, towards the end of the year we will start to see increased pressure on import costs should the pound remain this weak, or indeed deteriorate as has been mooted.
In 2015, the UK imported £38.5bn worth of food, any of which not purchased in sterling is set to see a sharp increase in cost due to the weakness of the pound. The extent to which this will translate to inflation for the consumer is unclear; however we anticipate something more than the 1.6% originally forecast for 2016.
Long term future is tarnished with propaganda
The leave campaign has been openly critical of the Common Agricultural Policy (CAP), branding it as wasteful and bureaucratic. However the £2.4bn in direct payments made to farmers in 2014, combined with £4bn worth of wider agricultural funding makes up 55% of the UK’s total income from farming, and as such the reliance on this money for food production is significant.
While a complete removal of funding for farmers in the UK would be nothing less than reckless, funding at the same level as provided by the CAP will be costly. Any reduction in funding will result in further inflation for the consumer, as farmers either charge more for food, or fail.
As important as CAP, is the matter of free trade. While the UK government will be keen to maintain free trade with the EU, this will likely come with a significant concession from the free movement of people, something which has been a cornerstone of the argument to leave the EU. Even if we were to negotiate free trade in exchanged for more relaxed borders, at this point there is no guarantee that we will be able to negotiate a deal better than that which we already enjoy. In any case, still further fuel for the inflationary fire as retailers are faced with increased costs of doing business which they will struggle to absorb.
Cheap and seasonal labour under threat
Without the freedom of movement, the cost of producing food in the UK will come under further upward pressure, as cheap seasonal labour, imported from the EU, and enjoyed by many food producers in the UK would be choked. This is another contributor to increased costs of doing business for food producers in the UK, unless as part of the UK’s negotiation with the remaining EU nations allows more relaxed movement for those seeking employment in the UK.
Already low volumes are a positive for retailers
Aside from the largely negative picture in terms of prices, grocery retailers can be somewhat more confident when looking at the prospect for grocery volumes. While we don’t expect any significant uplifts, the essential nature of products will provide some support. And indeed, grocery volumes are low, at 2011 prices sales of food & grocery products in the UK are set to be just 0.2% more than they were in 2011, and in 2015 they were 0.2% lower than in 2011. This is weak in comparison to the non-food market, set to grow at 2011 prices by 7.9% between 2011–16e. Even in the face of inflation, we don’t anticipate consumers to buy less, instead as we saw during the recession and subsequent years of recovery, we expect them to buy smarter. Only if we start to see steep and significant inflation, which is not something Verdict expects, will volumes be damaged materially.
The biggest threat to volumes for retailers is that posed by reduced net population growth. In the most recent update from the ONS, the UK population rose 0.8%, or by 513,300 people in mid-2015 versus mid-2014. Net migration counted towards 65.4% of this increase, and with a planned reduction in net migration to less than 100,000, population growth would have been halved in 2015, restricting the potential uplift to volumes that UK grocers would enjoy.