Inflation spiralling as real wages dwindle is putting retailers in a bind about passing the cost on to consumers.

In the month before the Brexit vote inflation stood at only 0.3%, as measured by the Consumer Prices Index. But it has now spiralled to its highest level in five years – 2.9%.

British Retail Consortium (BRC) head of retail insight and analytics Rachel Lund says retail is “running out of options” when it comes to continuing to protect shoppers from significant price increases.

“The reality is there’s a limit to how much retailers can absorb into their margins,” she explains.

While non-food prices have remained deflationary – in part because of hedging contracts, competition and heavy discounting at the start of the year – rising inflation began feeding into food prices back in February.

This is due to the shelf life food has and its shorter stock turnaround time, Lund explains.

However, non-food deflation reached its lowest rate in more than four years in August, suggesting it too is about to enter into a period of inflation.

The simplest solution would be to pass on the price increase to consumers.

However, inflation is happening at a time when real average weekly earnings have been in decline, year-on-year, for months.

With consumers feeling the pinch, it would take a brave retailer to hike prices and risk consumers deserting in favour of a cheaper rival.

Co-op chief executive Steve Murrells says passing on as little inflation as possible to its customers is the “right thing to do as people are becoming more strapped for money because of Brexit”.

The pressure on margins is only likely to worsen for retailers in the immediate future.

“Our outlook for the sector generally is quite downbeat,” says Richard Lim, chief executive at insights firm Retail Economics.

“We think the pressure on disposable incomes for households will be most intense in the final quarter of this year.”

Retail Economics forecasts inflation will reach a peak of 3.1% in November, and predicts real earnings will only return to growth in the middle of 2018.

Aldi and Iceland

Aldi this week reported a decline in profits and reduced margins as it seeks to shield consumers from price rises, but even the privately-owned discounter, which prides itself on being lean and nimble, has been forced to raise its prices.

“Pricing is clearly the biggest challenge we all face,” says Aldi UK and Ireland chief executive Matthew Barnes.

“Aldi is proportionately a cheaper business to run than it was 20 years ago”

Matthew Barnes, Aldi

“Inflation and commodity costs and the fall in sterling post-Brexit is a huge challenge for all of us.”

Aldi remains defiant though. Barnes thunders that, despite the profit drop, the retailer feels “stronger than ever” and able to maintain its price advantage against the big four.

He says that “lots of little things can add up to big differences” such as a focus on efficiencies in the supply chain and lowering energy costs.

“We have reduced our cost base by over 5% in 2017,” says Barnes. “Aldi is proportionately a cheaper business to run than it was 20 years ago.”

Meanwhile, Iceland boss Malcolm Walker says he is keeping a close eye on suppliers to ensure customers get a good deal.

“We want to make sure suppliers are not using inflation as an excuse or an opportunity. If there is a justified price increase we have to take it, but obviously it is eroding the margin because we don’t want to pass it on,” says Walker.

Shrinkflation and beyond

Lim suggests that retailers work with suppliers to try and mitigate the impact of rising costs and prices. Businesses can “essentially re-engineer their packaging sizes and things like that”, he says. 

But while shrinkflation is a popular tactic in food, it is not possible across all product categories. 

Planet Retail macroeconomics specialist and retail analyst Tatjana Wolff points out inflationary pressure in non-food is particularly high because it “mainly has to be imported”. And Lim predicts one of the hardest hit sectors could be electricals; price rises within the sector is likely to spark a sharp tail-off in demand because “non-discretionary spending has quite high responsiveness to changes in price”.

According to the BRC, the Government will play a pivotal role in the outlook for retailers.

“It is imperative the Government puts the UK’s consumers at the top of its agenda in the negotiations on our future trading relationship with the EU,” says Lund.

Things are likely to get worse before they get better for both consumers and retailers. Retailers will have to be at their most creative and nimble to ride out the inflation storm.