UK inflation, including for food items, has been falling recently. This means that prices have been still increasing, just more slowly than before. Yet, for food, modelling shows inflation might in time actually turn negative in the right conditions. Given that inflation for essentials disproportionately squeezes households’ ability to spend on other items, this matters not just to food producers and retailers, but also any business dependent on discretionary consumer demand. While forward looking models indicate rapidly falling food price inflation, major uncertainties about the outlook remain. Nevertheless, the time may be approaching for some businesses to consider whether they can capitalise on a potential uptick in consumers’ purchasing power in the next 6-12 months.
For consumer food prices, negative inflation is fairly common
Inflation reflects the rate at which prices of goods and services rise over time, eroding the purchasing power of money. Unsurprisingly, the focus of recent economic commentary has been on the ascent of prices, with less attention on the possibility that they could reverse course. One sector stands out with the potential for an actual decline in prices: food, given the unique volatility of its underlying drivers1. So, are we on the cusp of experiencing negative inflation in food prices?
Food, a basic necessity, might seem immune to price drops given its essential status. However, historical experience and developments in the underlying drivers of consumer prices (see next section) suggest otherwise. Indeed, in periods of both high and low general inflation, it is not unusual for various individual items to exhibit price reductions from month to month or year to year. Factors such as weather, seasonal production cycles, changes in consumer demand, and price promotions and competition between retailers, can all influence the prices of individual food products.
In that sense, what happened with UK food prices since the end of 2021—with large price increases for almost all items—was a departure from the normal pattern. In the period from January 2016 to September 2021, in an average month, more than 50% of the food item categories tracked by the Office for National Statistics saw prices decline, relative to the same month a year earlier. In contrast, in July 2022, not a single item category decreased in price. Most recent data suggests that things may now be normalising: negative inflation for individual food items appears to be making a return. (Exhibit 1)
Even at the level of the entire category, food prices have experienced negative inflation in the past, often driven by volatility in global energy, fertiliser and commodity prices feeding through into a cyclical pattern in consumer food prices. Since January 1989, there have been five episodes of negative inflation lasting between 11 and 33 months—and therefore not driven by seasonal variations. Such instances, while not regular, highlight that the food market is not immune to deflationary pressures.
The drivers of UK food inflation suggest further moderation to come
In addition to the statistical likelihood of price falls for food items, developments in the key drivers of food price inflation also suggest that inflation is on its way down and could turn negative. Historically, consumer prices for food in the UK have been highly influenced by global prices—of energy, fertilisers, and raw materials, as well as finished products. Indeed, even for food commodities produced domestically, such as flour and sugar, prices tend to be set in international markets. Of course, how much these prices change in domestic terms also depends on the exchange rate between sterling and other currencies.
Aside from energy and housing, food and non-alcoholic beverages have made one of the largest contributions to the UK’s high inflation in the last two years. The food category only has a 12% weight in the UK consumer basket but was responsible for 21% of the overall CPI inflation in the 12 months to September 2023. This is because its inflation rate—at an average of 16.5%—was more than twice as high as price rises in other categories, which averaged 7.3%. In the UK, a higher level of 12-month average food price inflation has only been recorded twice in the last 75 years, in 1952 and in 1974-782.
A sizeable proportion of the very high price increases experienced in the UK can be explained by global factors. In 2021, commodity prices were already elevated on the back of COVID-19 related supply chain issues. In the wake of Russia’s invasion of Ukraine in early 2022, international markets for energy, fertilisers, and food commodities, experienced a significant further surge in prices. The World Bank’s commodity indices for these goods in April 2022 were 77%, 247%, and 85% higher, respectively, than three years previously. Within energy, European natural gas prices spiked by 554%. Subsequently, these heightened prices worked their way into UK consumer prices for food.
Exhibit 2 shows the strong correlations between changes in UK consumer prices for food and these global commodity prices. What is notable, however, are the lags with which commodity price changes feed through to end-consumer prices: the correlation only becomes strong when you consider changes in commodity prices several months ago. On average, over the last 10 years, it has taken 11-12 months for global input price fluctuations to show up in UK consumer prices. Using lagged data on input variables, three international factors—energy, fertiliser, and food commodity prices (expressed in pounds sterling)—can explain 87% of the variation in overall food prices paid by UK consumers.
There are two good indicators embedded in that statement. First, if a similar relationship continues to hold going forward, then already observed changes in commodity prices can give a strong indicator of future consumer food price inflation in the UK. Second, the relevant global commodity prices have come down very considerably in the last 12 months. The global energy price index dropped by 20%, fertiliser index by 32%, and food commodity index by 5% from September 2022 to September 2023. Such movements are not just a slowing down of price rises—they point towards significant downward price pressures, potentially resulting in negative food price inflation.
However, there could be upward shocks in store
Inevitably, the kind of model described above cannot capture the many complexities of price formation. For example, domestic wages in agriculture, food manufacturing, transportation, and retail have an impact on the costs, and hence prices, of food items on the shelf. In addition, there are many other costs, other than energy and raw materials, which go into the final product purchased by the consumer. These include things like packaging, but also compliance with regulation, as well as the back-office costs of all businesses in the supply chain. With UK wages currently increasing at record rates, such costs are likely to maintain some upward pressure on consumer prices.
Moreover, the picture of reducing global commodity prices is neither uniform nor certain to last. With heightened geopolitical risks, still-fragile supply chains, and high incidence of extreme weather events, commodity prices are more likely to exhibit roller-coaster like volatility than consistent trends up or down. Indeed, in the last few months, oil prices have started rising again, and within food commodities, some—such as rice, sugar, and cocoa—have been becoming more expensive for a while. And the time lags between changes in commodity and consumer prices have oscillated somewhat, creating a further source of uncertainty about future consumer price changes.
Lower, and possibly negative, food price inflation could create opportunities
In broad terms, if lower food price inflation occurs, it would create the conditions for a more robust outlook for businesses. This may generate opportunities for businesses to rebuild margins, and with less erosion of households’ purchasing power, consumers are likely to spend more—not just on food, but on other, more discretionary items, too. However, given the volatility and uncertainty in the pricing environment, businesses cannot rely on a single forecast of the future. Constant vigilance, and agility in pricing approaches, will continue to be important.
Having said that, now could be a good time to build optionality into product and channel offerings that could rapidly react to any shifts in purchasing power. High inflation in energy, food and housing has been particularly tough for lower-income households. For this segment, the peak may be past, even if the broader economic outlook remains challenging. Indeed, while consumer sentiment dropped in October 2023, it declined less among the lowest-income households. More broadly, as the prices of essentials stabilise or even decline, consumers’ appetite to trade up, pay for convenience, or make discretionary purchases may make a return.
1. Other categories which share features with food in this respect include fuel for transport and heating. Indeed, energy prices made a negative contribution to UK CPI inflation in July and August 2023.
2. The RPI, rather than CPI, measure of inflation has been used here to capture a longer time series. RPI food price statistics are available from June 1948 onwards.