U.K. supermarkets may be masking the true scale of price discounting, complicating the task facing policy makers as they debate how long to keep interest rates at a record low.
Under pressure from German discounters Aldi and Lidl, the so-called big four grocers are battling for business by cutting prices. What government statisticians fail to capture are special deals such as three-for-two offers and vouchers offering money off fuel if shoppers collect enough loyalty points.
The question of why supermarket prices are falling, and by how much, is part of the monetary-policy debate in Britain, with Bank of England officials divided over whether they signal weak demand in the economy. Investor expectations are for the BOE to begin raising the 0.5 percent benchmark rate in the first quarter of 2015.
“If all the deals and offers aren’t included, it suggests inflation is a little bit lower” than official estimates, said Howard Archer, an economist at IHS Global Insight in London. “Price wars aren’t showing any signs of easing and are probably going to be a factor holding down inflation beyond the end of this year.”
Wal-Mart Stores Inc.’s Asda unit, the second-largest food retailer, slashed prices in November and Tesco Plc and Wm Morrison Supermarkets Plc followed suit this year with what they pledged to be permanent price cuts on essential items such as milk, bread, broccoli, cucumber and tomatoes.
Between Asda, Tesco, Morrison and the Co-Operative Group’s retail unit, U.K. grocers will invest about 1 billion pounds ($1.7 billion) this year in lower prices.
Some discounts, such as those on single products, are showing up in the data. Food and non-alcoholic beverage prices, which account for 11 percent of the basket of goods that make up the consumer price index, have fallen 2 percent since February. That’s helped keep U.K. inflation below the BOE’s 2 percent target for six months.
The pressure on prices is expected to be confirmed by retail sales data due tomorrow, which will show the deflator used to calculate the volume of goods sold. Sales are predicted to have risen 0.3 percent in June from May, according to the median estimate of 21 economists in a Bloomberg survey.
“We take account of straight sales on single products, we don’t take account of any of the more complex discounts,” Richard Campbell, an inflation statistician at the Office for National Statistics, said in a July 21 interview. “As the retailers evolve their practices there’s a question about how we make sure we’re on top of it, and make sure we’re capturing the best reflection of prices.”
The offers form part of a wider debate about how consumer-price inflation is measured in the U.K. Paul Johnson, director of the Institute for Fiscal Studies, is leading an independent review of the CPI statistics and is due to report before the end of the year.
“There’s fierce competition in the sector as the large retailers attempt to protect and grow market share,” said Richard Lim, head of business information at the British Retail Consortium, a lobby group. “There’s a big structural change going on in the sector, there’s a lot of competition from the discount side of the market and that’s put the focus on value for consumers. This looks set to continue.”
In the minutes of their June policy meeting, BOE officials said price cuts were “likely to bear down” on inflation in the second quarter. The effect “was uncertain and their wider implications would depend on the extent to which other retailers followed suit,” they showed.
While some policy makers began to argue this month that the risk of higher borrowing costs undermining the recovery has diminished, BOE Governor Mark Carney said in a speech today that “extraordinary forces” still weighing on the economy mean rate increases will be gradual and limited. Sonia forward contracts point to a quarter-point increase in February.
BOE officials have to decide whether consumer sensitivity to price changes is a signal of weak demand or whether they would have been generated by the emergence of discounters, regardless of the strength of the economy. While price wars aren’t expected to be permanent, they may have an effect on inflation for as many as three years.
In addition to competition, lower agricultural commodity prices and the stronger pound may also be depressing food inflation. Sterling advanced 11 percent in the past year, making it the best performer among 10 developed-nation currencies tracked by Bloomberg. World food prices fell 2.8 percent in June from a year earlier, according to the UN’s Food & Agriculture Organization.
“This is likely to be just short-term, as weather impacts and an increase in the world population will boost prices in the coming years,” Bruno Monteyne, a former Tesco executive who now works as an analyst at Sanford C. Bernstein in London, said by phone. “Supermarkets will not take that on the chin. They like to give the impression that prices are dropping, but studies have shown that any increase in commodity inflation is passed on straight away.”
Supermarkets are starting to move away from the more complex offers, which have dominated the retail landscape for two decades. Tesco said in February promotions had become “too complicated” and pledged lower everyday prices instead. Morrison followed in May, promising fewer and bigger promotions.
Changing the methodology to capture more complicated deals would require assumptions about consumer take-up of such offers, according to the ONS, which has no plans to do so.
“More complicated offers are often a problem to capture in the data,” said Neville Hill, an economist at Credit Suisse Group AG in London and a former U.K. Treasury official. “There’s confusion when price wars happen.”