Trade deficit means UK to suffer under rising food costs

By Laura Crowley

- Last updated on GMT

Related tags: Inflation

The UK is badly positioned to cope with rising food prices because
of its trade deficit causing concerns of a recession, according to
a report by Ernst & Young.

Its economic forecasting group, the Item Club, said the UK is "more exposed"​ to rising world food price increases than its peers, France and the US. While the UK runs a trade deficit in food equal to 1 per cent of GDP, the US is in balance and France runs a surplus of 0.5 per cent. Because it has a greater dependence on imported food, and because the sterling has become increasingly weak, UK manufacturers are facing steep rises in input costs, said the report. Companies across the food industry have had to find ways around the problem without damaging profits. But as the situation is only set to worsen, "the implications for business are profound"​, said the report, with firms expected to increase prices. "The UK's deficit in food, beverages and tobacco has deteriorated by 14 per cent over the last year, and sterling weakness and further rises in world prices will add to the deterioration in the terms of trade, thereby dragging down growth,"​ said Peter Spencer, chief economic advisor to the Item Club. He also said the spiralling global food and energy prices draws attention to the nation's inflation-targeting regime, which encouraged an excessively loose monetary policy and helped to suppress inflation "leading to the credit boom that has now turned to bust"​. Increasing food prices ​World food prices have been steadily on the up due to poor harvests damaging stocks, rising energy costs, a growing population as well as rising living standards in countries such as China that translate to an increasing demand from emerging markets, and competition for grain for use as biofuels. Food inflation is now at 6 per cent, according to the report, while oil is at a record high of over $125 a barrel, and energy prices are rising by 10 to 15 per cent. Meanwhile, wheat and maize prices have more than doubled since the end of 2005. Experts have said the situation is only going to worsen before getting any better. Food prices are still rising, and the cost of oil could reach $150 per barrel, said Ernst & Young. For the UK, rising food and energy prices now contribute over 1.7 percentage points to Consumer Price Index (CPI) inflation, "leaving little room for other price increases if the government's 2 per cent inflation target is to be met"​. Effects on the industry ​The report said input costs have increased 23.3 per cent over the year up to April, while output prices rose just 7.5 per cent in response to consumers tightening their belts and companies squeezing margins. However, the Item Club said: "The latest commodity price rises may force companies to harden their stance with customers, leading to yet higher inflation. In this new environment, companies are redefining the economics of their business models. More than ever, they are leveraging global scale to hedge against price fluctuations, improve efficiency in operations and review value propositions and pricing." ​Companies, such as ingredients firms CP Kelco, FMC Biopolymer and Jungbunzlauer, have had to introduce price increases across their product range to combat the higher prices. Other firms have opted for alternatives to expensive ingredients, such as dairy replacers. UK food retailers have been resistant to passing on farm gate price prices. Earlier this month, Marks and Spencer ended its pasta supply contract with Fenland Foods causing it to mothball a factory after the retailer sought cheaper supplies. The Item Club said the current problem can be eased by manufacturers, but not solved, by reducing value-added and launching more economy lines. But basics, such as bread, rise in line with the main input price. "Profitability of food producers was already under pressure from supermarkets' concentration of buying power and now is being hit further by input price rises that are difficult to pass on,"​ said the report.

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