Cautious optimism for growth of UK economy and food demand

Cautious optimism for growth of UK economy and food demand

Siôn Roerts
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Siôn Roberts

With UK economic growth set to continue, albeit weaker than anticipated, ongoing deflation and plenty of uncertainty ahead, we get the lowdown on what lies ahead for the food sector from Siôn Roberts – a senior partner at European Food and Farming Partnerships (EFFP), a specialist agri-food business consultancy that works along the whole supply chain

There is nothing permanent except change. Those were the words of Greek philosopher, Heraclitus, around 500 BC but they could have been written to describe the economic situation today.

In the summer of 2015, despite concerns over China, we argued that the outlook for the food industry wasn’t as bad as some might fear. There were growing concerns over the Chinese economy slowing down, but smaller levels of growth versus 10 years earlier in what has become a much larger economy weren’t necessarily a disaster.

Lower food prices in the UK, combined with consumer incomes that were finally rising after a long period of stagnation, meant that food affordability was improving after having deteriorated since the financial crisis in 2008. Farmers were unhappy about falling commodity prices, but prices had been pretty strong for several years up until that point, and what seemed to be happening was the market was slowly finding a new base.

Despite restructuring in food supply chains and a margin squeeze on those involved, the overall economy seemed to be continuing to take small steps in the right direction, offering hope for those in the food industry.

Perhaps inevitably, since then much has changed, but what implications might that change have for the food sector? 

Graph I Food Price Indices

Oil prices

On the supply side the most obvious change has been in the price of oil. International oil markets are in oversupply and prices continued to fall, before bouncing from a low to around US$30/barrel in January, back towards $40/barrel at the start of March. In January 2016 the International Energy Agency estimated that this year global supply would be one million barrels a day in surplus, largely as a result of Saudi Arabia, Russia and the US increasing production and fighting for market share. There are also new players in the market, with Iran trading internationally again following the lifting of sanctions.

There is some evidence that oil prices are stabilising and could even begin to rise again, according to the International Energy Agency (IEA). But the outlook still remains uncertain. What’s really interesting is that low oil prices should be good news for all – reducing production and logistics costs, living costs and inflation, which combined with low interest rates should result in economic stimulus. Yet the rate of change in oil prices has actually had the opposite effect, destabilising markets and causing economic uncertainty.

Moving on from oil, when it comes to agricultural commodities the picture is slightly different, although markets generally remain soft. Most prices remain towards the bottom end of their trading range and the impact of plentiful global stock levels, along with reasonable weather and low oil prices, has kept prices depressed. The key exception to this would be sugar, as Brazilian supply has been adversely affected by the weather. 

Graph II 10 Year Oil Monthly Prices

Wage growth

On the demand side, perhaps the biggest surprise has been the moderation of wage growth closer to home. Before the crash in 2008, wage growth in the UK typically ran at about 4% per annum. Since then it has broadly been around 2%, although the Bank of England had forecast an increase to 3.5% for 2016. What’s surprising, though, is that this anticipated growth isn’t materialising as quickly as was forecast, despite the overall economy looking positive.

There are many reasons for this, but the key one seems to be the structural change that is happening in our labour markets – people are working to an older age, migration means that there is plentiful labour supply and, in many cases, people are underemployed. What this means is that the erosion of spare capacity that typically drives up wages simply isn’t happening to the extent that was anticipated. This is significant because wage growth is critical to consumer expenditure.

National Living Wage

There is a curve ball in this debate, too. The implementation of the National Living Wage from April 2016 will put more money in workers’ pockets, but may also impact on the financial performance and even viability of some businesses, so the overall outcome is unclear at this stage.

The big question in this debate is whether consumer spending on food will increase even if wages do improve? The latest data from Kantar suggests that retail grocery sales are up by around 0.5%, but the price war continues as retailers scrap for market share, and food deflation is still in place at around -1.5%. This combines with the massive growth of the discounters, with Aldi and Lidl together now almost the same size as Morrisons. So, while wage growth appears to be in the right direction, albeit at a slightly lower level than anticipated, there is some thought that it might still take a while for consumer spending to respond, particularly given the on-going march of the discounters.

What does this mean for the UK food sector?

Well, despite the doom and gloom, the outlook we would argue probably still doesn’t look too bad. If you look behind the headlines, the UK economy still seems to be in growth and is probably doing better than the changes in the FTSE would suggest. The recovery remains intact and unemployment is at a low level. Yes, there is a risk of global recession but it is far from clear-cut at this stage that it will happen and there are still plenty of positives out there.

What’s more, massive falls in the price of oil would historically be a good indicator of sustained economic growth to come and, for the UK and the European Union at least, this should be a massive benefit. In the short term we have additional political uncertainty as a result of the Brexit referendum, but the UK consumer position continues to gradually improve and this should, eventually, lead to increased sales. In addition, whilst it was looking like UK interest rates might start to increase this year, this no longer looks likely in 2016.

Markets often overshoot on the upside and the downside. As Ben van Beurdan, CEO of Shell, said recently after announcing an 80% slide in profits: “Can oil prices go lower? I’m sure they can. Will they go lower? I don’t know.” But he also said: “If you look over the slightly longer run, you are not going to see structurally lower oil prices in the $30s.”

As always, it is impossible to accurately predict the future and nobody likes to catch a falling knife. Growth in the UK looks set to be weaker than we thought six months ago. Yet for those in the food sector the economy could just be strong enough to keep things ticking along – not stellar but not a disaster either. There are significant risks – a major weather shock, global recession or Brexit becoming a reality. Yet, for those in the food sector there is good reason to believe that the economy could continue to perform OK, albeit a little less well than in recent years. This should, in time, feed through to increased demand for food. Yes, there is a bit more deflation to come and there is plenty of uncertainty out there, but we should remain cautiously positive about the outlook.

This article was originally published in the spring issue of The Marketplace from UK foodservice supplier Reynolds.

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