Blog: Farmers understand the danger of deflation

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Phil Bicknell, chief economist_182_275Phil Bicknell is the NFU's head of food and farming.

He writes:

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While some of us might think that stuff getting cheaper is a good thing, economists and business leaders get concerned about deflation. Generally speaking, if we expect to see lower prices tomorrow, then we’re more likely to put off our purchasing today. That delayed spending can be bad news for our economy.

quote mark graphic for web use_63_66To the shopper picking up a couple of pints of milk, the numbers might seem small, but the impact can be crippling to farm businesses.

Shoppers buying less stuff means businesses produce less stuff. The knock on effect is that businesses need to replace the equipment needed to produce stuff less often, and fewer workers are needed to produce that stuff.

In farming, we’ve been experiencing deflation since the early part of 2014 and the price falls are widespread. Whether it’s dairy, cereals, sugar or meat, we’ve seen prices of a whole host of commodities fall. For example dairy and pig prices are currently almost 20 per cent lower than they were 12 months ago. Lamb and beef prices have also under pressure in the recent weeks. The impact of deflation in agricultural products is already being felt. Profitability has come under pressure and margins have been squeezed. Take the dairy industry as an example.

To the shopper picking up a couple of pints of milk, the numbers might seem small, but the impact can be crippling to farm businesses. On average, farmers are receiving 8p a litre less for their milk than they did last Spring. Yet multiply that against the 1.3 billion litres that UK farmers produced in April and it collectively means that UK dairy farmers received over £100million less in April than they did in April 2014. They’ll receive £100million less this month, and next month, and the month after that unless prices improve. A drop of just a few pence in the price paid for a litre of milk has taken millions out of the UK dairy sector.

While the price of milk in shops is not always linked to farm gate prices, it is vital that retailers have transparent pricing back to farm.

It’s a similar story in other sectors. The averages for many agricultural commodity prices struggle to meet the breakeven point. We’re already seeing the impacts of deflation in agriculture. UK beef production for 2015 will be lower - why produce something if it loses you money? In the last quarter, tractor sales were 15% down on sales in the same quarter in 2015 and I expect tractor sales numbers for 2015 to fall to a new low. More worryingly, I expect that we’ll see a slowdown in capital investment by farmers. In the past, low prices for farm products meant that investment in farm buildings and infrastructure slowed significantly. The reality is that if we’re not investing in the resources we need for future production, it’s not a good omen for our future agricultural output.

The reasons behind commodity price drops are varied and complex, but few can ignore the fact that this is happening at a time when some of our leading supermarket chains are fighting for customers and market share. Price is a key part of their armoury and some of this will have been fuelled by lower commodity prices, energy costs and reduced margins. However, there is a perception that the supermarket price war adds further deflationary pressure to farmgate prices. In some instances, supermarkets will reflect production costs – the pricing models used on liquid milk by chains Tesco, Sainsburys, Marks and Spencer, Waitrose and the Coop underpins sustainable returns, for example. But such models remain the exception rather than the norm.

Carney’s view is that the deflation we’re seeing is driven by lower food and energy prices, and we tend to buy those things as we need them. Even if we’re expecting falling prices tomorrow, we’ll try to make sure we’ve got enough food to eat today. I’m much more anxious, because I know the implications of that 3% drop in food prices at the retail level. I know that the basket of UK farm commodities that makes up Defra’s Agricultural Price Index has fallen by 12% and is at its lowest level since November 2010. At the national level, I expect us to be measuring the drop in farming’s revenues in 2015 in billions rather than millions. That impacts on the bottom line for tens of thousands of farming businesses. Farmers are remarkably resilient, but continued deflation in the products we produce poses a very real threat to our industry.