Commodity crisis sparks fear of food inflation on high street

Warning that rise in wheat and barley prices will hit household budgets - and may force increase in interest rates

A spike in food-price inflation over the coming months is set to hit household budgets and pile the pressure on the Bank of England to raise interest rates, an influential research firm has forecast.

Grocery-price inflation is on track to jump from 2 per cent to 4 per cent by the end of the year, according to the market research firm Kantar Worldpanel, as events such as fires and droughts in Russia and Ukraine lead to soaring prices of wheat, barley, palm oil, cocoa, animal feeds and meat.

Other, industrial, commodity prices have been rising for some months, in response to demand from resurgent emerging economies such as China and India. These too will feed through to high-street inflation next year.

In another part of the high street, Next, the fashion retailer, said that clothing prices may rise by up to 8 per cent next year. This reflects higher world cotton prices and pressure on capacity in China, where many garments are sourced. The 25 per cent fall in the external value of the pound between 2007 and last year has boosted import prices. Together, these factors threaten the biggest inflation shock in 20 years.

Vladimir Putin, the Russian Prime Minister, yesterday warned that the country's recently imposed ban on grain exports could be pushed into next year as it seeks to conserve domestic supplies. Higher food prices will deal a further blow to UK household budgets at a time when they are already squeezed by tax rises, surging petrol prices, and many are anxious about their job prospects.

A rise in VAT to 20 per cent on 4 January promises to hit poorer households especially hard.

This deadly cocktail of measures is set to create a precarious balancing act for the Bank of England's Monetary Policy Committee, as it weighs the risk of reining in inflation by raising interest rates from their historic low of 0.5 per cent – or choking a hesitant economic recovery.

While food-price inflation hit a record low of 1.2 per cent in April and May this year, a rise to 4 per cent, as forecast by Kantar, is likely to lead to supermarkets increasing their prices.

Clive Black, head of research at Shore Capital, said: "I would expect the bulk of the food-price inflation to be passed on to consumers.

"The fact is that the trade knows that consumers are under pressure, and the consumer will come under greater pressure in 2011, as VAT goes up and the wage awards will probably not go up in line with inflation."

Mr Black said he expected "slow and steady" food inflation – up to 3 per cent – to remain for the "foreseeable future".

While the spike in food prices to 4 per cent will make consumers wince, it compares favourably to the grocery inflation peak of 9 per cent seen at the end of 2008.

Ed Garner, a director at Kantar, said: "There is going to be some inflationary pressure of about 4 per cent by the end of the year but the talk of food-price Armageddon is overstated."

However, he suggested several reasons for caution. "The UK grocery market remains highly competitive with increasing levels of promotion and discount which will limit the ability to pass on raw material increases in full," he said, adding, "the pound has recently been strengthening against the US dollar and the euro. This should help to unwind the inflationary pressure we saw at the beginning of 2009 when the pound fell sharply and, as a result, we imported inflation."

Despite Kantar's caution, there has been a substantial hike in commodity prices over the past week in the wake of the Russian and Ukranian harvest crisis. The price of barley, a crucial source of food for Europe's livestock, has more than doubled in the last six weeks. The price of European feed barley has risen to €210 (£175) a tonne, up 130 per cent from €90 a tonne in mid-June.

Wheat prices soared by 25 per cent last week. However, the United Nations Food and Agriculture Organisation has played down fears of a global crisis, particularly given that the US is forecasting a bumper crop this year.

In the UK, families spend around 12 per cent of their budgets on food, and, because much of it is processed, the relative importance of raw materials is dampened by costs such as wages, marketing, packaging and distribution.

But the scale of the wheat-price hike, at almost 100 per cent in two months, seems sure to feed through to the price level and raise the cost of living. In poorer nations the hardship is likely to be more acute, as a much higher percentage of household budgets are accounted for by basic food staples. In 2008 a rapid escalation in prices and food shortages sparked riots from Mexico to Indonesia.