EU Exit Perspectives: How might tariffs affect retail food prices?

Friday, 18 December 2020

In this week’s blog, our strategic insight team, Tom Forshaw and Sarah Baker, cut through the media hype around the impact of tariffs on food prices, exploring the relationship between commodity prices and what shoppers actually end up paying at the tills.

The outcome of a no deal scenario is likely to have an impact on consumer food prices here in the UK but maybe not as much as we’re led to believe. Price transmission in agricultural supply chains is by no means straightforward. Often when food price inflation is discussed, what is meant is changes in raw commodity prices. This is fundamentally different from the food that consumers buy, which has undergone varying degrees of processing.

There’s a long list of factors that affect retail prices, such as imbalance in power and imperfect knowledge in the supply chain, retailer and processor margins, transport and marketing costs and macro-economic variables, including exchange rate movements. So in addressing food price inflation at the consumer level as distinct changes in world market ‘food’ prices, economists and policy-makers need to address how world market prices are transmitted through to retail prices.

Here at AHDB, we’ve explored the relationship between the prices of raw materials (commodities) and retail prices to find out what causes retail prices to rise. First, it’s important to acknowledge around half of all food consumed in the UK is imported, with the vast majority of that being imported from the EU. This means both world commodity prices and relative exchange rates, known as the ‘terms of trade’, are a key determinant in food prices. When sterling weakens against other currencies, the price of imported goods rises, pushing up the price of the raw materials imported for processing and allowing domestic prices to rise to the same level as imported goods. On the other hand, goods exported from the UK become more competitive when sterling is weaker. If there is no deal on trade with the EU, most economic forecasters suggest that the pound would fall in value against major global currencies, increasing the cost of food imports.

But retail food prices are affected by more than just the cost of raw materials. For example, only about 11% of the price of a loaf of bread is accounted for by wheat. The rest is processing, packaging, transport, labour, wholesale and so on, as well as macro-economic variables ranging from the unemployment rate and earnings to oil prices and exchange rates.

This lack of a direct price transmission mechanism has led to academics and economists scratching their heads to try to quantify the relationship between commodity and retail price for food. A Defra-funded study in 2011 developed a model which found that every 1 per cent increase in global food commodity prices led to an average 0.27 per cent increase in the consumer food price after two years. In reality, this differs between food groups, with the figure for bread being estimated at 0.331 per cent, meat 0.377 per cent, fruit 0.251 per cent and vegetables 0.456 per cent.

With the commodity cost only acting as a small percentage of the overall costs and considerations retailers need to take into account when setting prices, they are typically left with three options when faced with rising input costs: pass costs onto consumers; reduce profit margins or mitigate the impact through the supply chain and re-engineer products.

Most retailers will use a combination of all three options to remain competitive. But complexities arise when looking at specific sectors – market position, pricing power, elasticity of demand and length of supply chain are all important factors to consider when assessing the magnitude of the price transmission through to consumers.

Overall, the results suggest that in the event of exiting the EU without a trade deal, lowering tariffs on imported goods may go some way to mitigate food price inflation. It is also clear that the effect of tariffs is on the commodity value of products – and these tend to represent a small proportion of the value of food products in the retail market. If there is no deal, there are likely to be other factors at play, notably exchange rates, which will also impact on food prices. But in the current climate for UK retailers, it is expected that consumers would have to bear at least part of the burden of rising costs.

Read the full analysis:

EU exit: food, farming and agriculture

Tom Forshaw

Senior Analyst - Policy

Sarah Baker

Strategic Insight Manager