Consumers feeling pinch but businesses have taken big share of pain

With recent announcements from Ofgem that July’s price cap will drop significantly, ensuring that a household with typical use will pay £2,074 per year, there are signs of optimism that when the energy price guarantee ends this month consumer bills for energy will start to ease.

Despite this, high and growing food prices mean that we have transitioned to a cost-of-food crisis, with many households, particularly those on the lowest incomes, unlikely to feel much comfort from a slight easing in electricity and gas prices.

The inflation rate for food and non-alcoholic beverages was 18.4% in May, so well above the headline inflation rate. This has eased slightly from the highs we saw in March but remains close to record highs. Some items, such as sugar and olive oil, have seen the sharpest price hikes over the past two years, with the price of sugar 41.5 percentage points higher in April 2023 than its price in April 2021.

To combat this, many households have turned to own-label or value products. But as prices of these products also continue to rise, the worry is that there are few (or perhaps zero) cheaper alternatives for households to “trade down” to going forward – meaning the poorest households are being forced to simply cut down on the amount of food they buy and consume.

Given the spikes seen in food prices, many critics have turned on businesses, particularly those in retail sectors such as supermarkets, accusing some of profiteering from inflation by increasing prices more than is necessary in order to benefit from the current inflationary pressures.

However, firms have also experienced very high and rising input costs over the past two years.

Businesses have not been protected to the same extent as consumers by energy price caps. This means, depending on the extent to which firms have fixed their energy costs, that many firms are paying three, four, five times what they were paying for a unit of gas or electricity pre-pandemic. Producer price inflation (PPI) measures the price of goods bought as inputs and sold as outputs (the so-called factory gate price) by UK manufacturers. In the middle of 2022, input and output PPI were at 24% and 19% respectively, while at the time consumer inflation was around 9% to 10%.

While we would expect that consumer inflation would lag input costs, the extent of the differences in these inflation rates shows that businesses were potentially absorbing significant cost rises and that these may feed through to consumer costs even when input costs start to come down.

May 2023 was only the second month that input and output prices for firms were lower than consumer price inflation since November 2020, suggesting that the easing in consumer prices may be on its way in the months to come – but as with the increases, there is likely to be a lag in the decreases.

Home-grown and imported food contributed significantly to input price growth, with food products also the highest contributor to output PPI, both of which are reflected in the high food prices facing consumers currently.

Further to this, in our latest Scottish Business Monitor (our regular survey of Scottish businesses) we found that employee costs had overtaken energy prices as the key cost concern for firms for the first time in the last year or so, as the tight labour market in the UK has put upward pressure on wages.

Until now, most firms have taken the brunt of these costs, with the latest ONS Business Insights And Consumer Survey (BICS) suggesting that around 57% of businesses had absorbed costs in the wake of higher prices. In comparison, just over one in three had passed on price rises to consumers.

Interestingly, though, this latter figure is on the rise, suggesting that more firms (although still not the majority) feel they can no longer absorb all these cost pressures.

The hope is still that inflation will fall over the course of this year, as we compare prices in 2023 to the much higher price levels of the second half of 2022. The Bank of England currently expects that inflation will be around 5% by the end of the year and be back close to the target of 2% in 2025, although the most recent data have given them pause to say that the risks to inflation skew significantly on the upside.

A falling inflation rate does not mean prices are falling though, rather that prices are rising less quickly. The evidence would suggest that the majority of UK and Scottish firms have broadly sought to protect consumers over the past year or so, but there is only so long they can continue to absorb these costs. While energy and input costs are starting to ease, wage pressures have significantly increased and may add to the inflation that consumers are experiencing.