The rising cost of food in Europe

Food prices in Europe continue to remain high and will decline only later this year.

In March, headline inflation in the Eurozone declined to 6.9% y/y (down from 8.5% y/y in February) due to a large drop in energy inflation to -0.9% (down from 13.7% y/y in February) as we mark the one-year anniversary of the jump in oil and gas prices after Russia invaded Ukraine.

However, food, alcohol and tobacco inflation rose again to 15.4%. At the same time, inflationary pressures have broadened and become increasingly entrenched; the core inflation rate (which excludes energy, food, alcohol and tobacco) edged up to a new record high of 5.7% (up from 5.6% in February).

While headline inflation will noticeably decelerate over the coming quarters (due to strong disinflationary base effects), food prices are expected to remain high for at least another quarter before a rapid normalization sets in.

Overall inflation in the Eurozone should average 5.6% in 2023 before receding to 2.6% in 2024, with core inflation remaining rather sticky as wages become the main driver of price pressures.

Food inflation will contribute almost one-third to overall inflation this year (up from less than 20% last year) and should average 8.0% before turning deflationary (-3.8%) next year.

Commodities

Cooling commodity prices suggest that other factors might explain continued prices pressures on food.

Global commodity prices have retreated sharply from their 2022 peaks: wheat and soy beans are now trading at 2021 levels, while corn is about 30% more expensive than in early 2021 and fertilizers remain about 50% more expensive than a couple of years ago; yet food inflation keeps rising.

Operating costs of food producers and retailers seem to explain the growing disconnect between upstream (commodity) and downstream food prices: energy (oil: +43% (2022 vs. 2021), wholesale electricity (+145%), packaging (+24% for paper, +18% for glass, +23% for metal, +16% for plastic), and labour (unit labour cost in the retail sector +5%).

Packaged food

It seems that packaged food companies rather than retailers have increased their prices the most.

Capturing over 70% of all spending on food in Europe, food retailers have historically driven most of the price increases over the recent past.

Food price increases rose in the second half of 2021 following the surge in agricultural benchmark prices before accelerating in the wake of Russia’s invasion of Ukraine.

Retailers have passed most (but not all) of their costs onto customers: In 2022 alone, food producers increased their prices by +17% y/y (compared to “only” +12% for food retailers).

Financials from listed food retailers confirm that costs rose faster than sales, with 2022 gross margins shrinking and falling below their pre-pandemic levels.

The European food sector was hit by higher costs in Q2 2022: At the time, the total cost index  for the sector increased by +6.7% while turnover grew by a meagre +0.8%.

Since then, turnover growth has been outpacing the cost index, suggesting that firms in the food sector have been increasing prices to make up for lost margins.

Feeling the pinch

Consumers will continue to feel the pinch. Households in Europe have already lost between 1.1% and 9.2% of purchasing power over the past year, especially in countries most dependent on food imports (especially in Eastern Europe).

Nonetheless, not all households are under pressure: Those in the bottom 20% of income distribution have been hit the hardest as they spend a greater share of their disposable income on non-discretionary goods.

According to a survey of the 5,000 consumers in 10 countries by the European Institute of Innovation and Technology (EIT), consumers have been cutting costs on non-discretionary expenses when possible, buying from cheaper brands or stores.

Over one third of participants reported buying less red meat, fish and poultry to cut costs.

However, cost-saving behaviours may not be enough. When consumers pay more for food, they spend less on discretionary items, which could slow the recovery.

A further rise in food prices +20% could lead to almost a 1-pp drop in consumption.