UK retail sector nears end of four-year deflationary cycle - BRC-Nielsen

Retail sector price deflation fell to its lowest rate in over three and a half years in June, according to a survey of the industry, as the effects of the weak pound and rising commodity prices continued to feed through.

Overall shop price deflation eased to 0.3% in June from the 0.4% drop in May, the BRC-Nielsen shop price index revealed on Wednesday.

Food inflation persisted however, with prices rising 1.4% as they did the previous month, though non-food deflation persisted at 1.4% for June, easing back from deflation of 1.5% in May back to the same rate as seen in April.

Fresh food prices rose 1.4% in June, 0.2 percentage points higher than in May and the highest increase since February 2014, while ambient food inflation softened to 1.% from the 1.8% increase in May.

Nielsen's head of retail and business insight, Mike Watkins, observed that with inflation rising in essential goods and services, many UK households are seeing household expenditure come under pressure, which is exacerbated by an income squeeze.

"Whilst this may add to the uncertainty around discretionary spending, the good news is that shop prices are increasing at a slower rate. Shoppers are also able to find further savings in retail with low price strategies across the grocery sector and competition across the marketplace keeping prices as low as possible," he said.

British Retail Consortium chief Helen Dickinson said the fact that prices are still down on last year should not be misunderstood.

"The year on year numbers belie the fact that prices have been heading upwards for the last six months; it’s just that significant deflation in the second half of 2016 means there has been considerable ground to make up in the year on year figures," she said, noting that although heading upwards, the speed of price increases was checked in June.

Dickinson said the steadying of inflation in June is likely to be a brief hiatus resulting from the interplay of short term influences on pricing, such as good weather delaying mid-season promotions into June and the longer term competitive pressures constraining the pass through of all costs.

"We expect shop price inflation to continue trending upwards in coming months."

Retailers are facing mounting cost pressures from underlying costs of goods and as a result of Government policies she said.

"There is a limit to the ability of retailers to protect consumers by absorbing these impacts into their margins, as a result further price increases are inevitable. With that in mind and with the UK’s trading relationships under discussion, it’s of the utmost importance that the Government does all it can to limit any further cost increases that could further adversely impact the finances of the UK’s consumers."

Analysts Clive Black and Darren Shirley at Shore Capital said that as prevailing currency hedging by retailers eases out of the system, to be replaced with new positions at lower prevailing exchange rates against the US dollar in particular, the pressure upon supply chains and retailers' business models, becomes more evident.

As such, the pair expect non-food deflation will continue to ease in coming months leading to a measure of overall shop price inflation to come through in the second half of 2017.

"Whilst this is so, commercial pressures, not least of which is variable footfall, potentially weakening consumer confidence - not aided by the prevailing British political classes it should be said - and negative differential inflation for many households, are likely to mean that whilst the shopper takes some inflation, the supply chain and retailer will continue to take some of the heat too.

"Indeed, for the non-food retail sector in the UK in particular, but not exclusively, cost recovery is a real challenge for many retail businesses as increasing prices can lead to demonstrably lower volumes and the challenge of negative operational gearing, particularly for store based operators with relatively high fixed costs in real estate.

For stock pickers, the ShoreCap duo see bigger ticket and non-discretionary retailers, particularly mid-market high street players, as being the most financially vulnerable to present market conditions, as seen with the recent profit warning from DFS Furniture.

Correspondingly, they see good discount, low ticket, affordable treats and non-discretionary retailers as being better placed for whatever challenges, should they emerge, the UK consumer economy throws up.