Food prices to reverse in year ahead as ingredient costs fall and manufacturers vie for shelf space

Posted by Daniel Palmer on 11th February 2009

The effects of the global economic crisis are set to create downward pressure on retail food prices as ‘tail-end ripple effects’ of high commodity prices subside and manufacturers battle for precious retail shelf space, according to a new industry report.

In its annual Australian Agriculture in Focus report, leading food and agribusiness lender Rabobank suggests the reduction in credit availability and the drop in consumption has had a substantial impact on the agricultural sector.

“As the economic crisis hit in 2008 the lack of credit availability created difficulties for all borrowers including farmers, processors, distributors and retailers,” General Manager of Rabobank Food & Agribusiness Research, Bill Cordingley, advised. “The exodus from futures markets, a shortage of credit for companies trading in agricultural commodities and the damage to consumer wealth have all added to the downward pressure on commodity prices.”

Mr Cordingley added that, while all agricultural commodities will be affected, the commodities that will be most impacted are those that are seen as discretionary spending such as natural fibres, wine and even dairy. “Particularly in developing nations dairy is still considered a discretionary purchase so prices are likely to drop along with the reduced consumption of milk, cheese and yoghurts,” he said.

Despite many of the impacts of the global economic crisis being negative for Australian agriculture, the fall in the Australian dollar has provided something of a buffer.

Mr Cordingley noted that while the currencies of many countries fell as investors sought the perceived safe haven of the United States and Japanese markets, the Australian currency declined more than most. “The Australian dollar was driven down by 30 per cent against the US dollar in the second half of 2008 helping to offset the falling US dollar commodity prices in export markets and the softening of prices at farm gate,” he said. “The second benefit of the global crisis was the collapse in input costs, fuel, energy, fertilisers and agrichemicals have all fallen well below the highs of early 2008 and with the global uncertainty continuing it is likely they will stay that way for at least the first half of 2009.”

A third key benefit of the crisis for Australian farmers has been the aggressive cutting of interest rates by the RBA. “Combined these factors mean that the full effects of the crisis, that are severe globally, will be somewhat softer in Australia in 2009, giving the industry the opportunity to manage through what will be a difficult year better than many competitors overseas,” Mr Cordingley explained.

Global supply and demand
The uncertainty around agricultural commodity prices will mean that there is likely to be a contraction in plantings and global cuts in herd and flock numbers, the report notes.
“A contraction in wheat plantings in 2009/10 together with a reduction in fertiliser utilisation (due to high input prices and a drop in commodity prices), is expected to result in a smaller world wheat crop this season,” Mr Cordingley said. “A repeat next year of the extremely tight supply issues seen throughout the world in grain in 2007 would certainly provide a more bullish outlook for global prices, given the relatively tight supply and demand balance for the 2009/10 season.”

Beef prices are also expected to remain steady, supported by herd cuts in the US market in response to reduced profitability. “Any substantial rainfall in the beginning of the year would potentially drive increased interest from restockers looking to take advantage of improved water and feed availability,” he added.

However, dairy, wine, wool and cotton are all expected to be negatively impacted by the economic crisis. “Dairy, wine and natural fibre demand is highly related to economic conditions as these commodities are still primarily a discretionary purchase for many buyers,” Mr Cordingley said. “Thus when incomes fall, products like milk, cheese, wine and apparel are often left off the shopping list. In ingredient markets, dairy use can also be cut to save costs – either by substituting to cheaper vegetable based alternatives or just reducing ingredient use altogether.”

The timing of the global demand recovery will be crucial to determining prospects for 2009/10, though the drop in input cost and the Australian dollar will ease some of the pressure on prices.

Food retail
Food prices have continued to be impacted by the “tail-end ripple effects” of last year’s commodity boom. While the cost of agricultural and oil-derived products fell sharply in the second half of 2008, lags ensured that retail food prices continued to increase through to the end of the year.

“This price ‘stickiness’ is a global phenomenon, with the retail costs of food remaining high or adjusting only slowly downwards in most countries around the world at present,” Mr Cordingley explained.

The Rabobank report said it was likely that retail price increases across many food categories would dry up (and in some cases fall) as 2009 progressed, as most of the forces that drove them started to reverse.

“We expect to see reduced costs of ingredients, fuel and plastics passed on to shoppers as processors compete to sell product in a challenging retail environment and retailers strive to keep consumers moving in through their doors,” Mr Cordingley concluded.