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Food price outlook: grumbling ahead.

Food prices have clearly been in the forefront of reducing inflation in the past three years. Unfortunately, consumer grumbling almost certainly will intensify this year as food prices, fueled mainly by slightly higher interest rates and increased farm prices, rise nearly 7%.

While consumers usually grumble about price tabs at the supermarket, the last justified complaints were in 1980 when prices for food increased 10.6%. In 1981, farm prices tumbled nearly 10% and food prices slowed to a 3% gain. Further weakness at the farm and the beginning of cost moderation in the distribution of food caused grocery prices to increase by only 2.2% in 1982. Declining interest rates, moderate increases in wages and reduced energy costs all combined to generate similar price moderation in 1983.

For 1984, meat prices at the grocery counter are expected to rise by 10%, a dramatic reversal from their price decline in 1983. Most other food categories are also expected to experience some price acceleration. Prices of cereals are expected to increase 5%. Changing price supports should restrain increases in dairy products to less than 4%.

As the dollar begins to weaken in purchasing power abroad, sugar prices should rise by 6%. Prices of fats and oils should slow to a 7% gain after increasing more dramatically in the latter half of 1983. A weakening dollar also will be instrumental in pushing up coffee and cocoa prices leading to a 4% gain for prices of nonalcoholic beverages. Jams and jellies also will show accelerated price gains, averaging more than a 5% increase. The impact of the heat wave on peanut butter and last year's early spring freeze upon fruit products will provide most of those increasing price pressures.

The only bright spot in projected grocery prices is in fruits and vegetables. An early spring freeze and unusually wet winter weather significantly increased prices of fruits and vegetables early in 1983. In the absence of a similar string of unfavorable weather conditions, price increases in those commodities should be less than 5% this year. No Pains from Labor

On the labor front, costs should remain modest, increasing slightly more than 6% per hour worked. An increase in Social Security taxes from 6.7% to 7% for employer and employee contributions will be a major factor generating accelerating labor costs, but part of these increased labor costs will be offset by productivity gains associated with increased use of grocery warehouses and increased modernization of units using scanner technology. Even allowing for some productivity slippage--as an increasing share of stores offer extended hours--labor costs per unit sold should increase by less than 4% this year, only a modest hike from 1983.

Prices of motor fuels declined in 1983. Moreover, falling oil prices lowered the energy costs derived from some petroleum products below those derived from natural gas. In order to prevent industrial customers from switching to fuel oil, natural gas distributors have been restraining price increases to them. The same may not happen this year but prices for natural gas or electricity should increase by no more than 7%.

Transportation costs probably will rise, but diesel fuel prices should not increase by more than 2 to 3 cents per gallon during the year, excluding local conditions. On average the cost of transporting products should not increase by more than 4% while utility bills per unit of energy should be increasing by less than 7% over the next 12 months.

Improving economic conditions should place upward pressure on the prices of materials used in packaging as the year progresses. A flurry of price increases for wood containers last summer caused some concern, but fortunately the strong increases in housing activity, which contributed to some of those price pressures, have since ended. The Real Culprits

If labor, energy, and transportation costs are not accelerating appreciably, and if an appreciable increase in the price of packaging materials is insufficient to substantially increase food marketing costs, then why should food costs at the supermarket rise more sharply in 1984 than in previous years? The two remaining important cost items, interest and farm product prices, must answer that question.

Currently, economists have more opinions about changes in interest rates than they do about most other economic issues. The dramatic decline in interest rates that began in the summer of 1982 but stalled last summer, was instrumental in holding down food marketing costs. No serious economist (although one serious Secretary of the Treasury) believes that interest rates will fall as much this year as last. Indeed, some reputable economists are maintaining that interest rates on both short-term and long-term maturities might average a percentage point above 1983 averages during the current year.

Clouding all the discussion on the direction of interest rates in this year's election. Certainly, the President's re-election prospects will be seriously damaged if the prime rate is rising significantly in November. Some analysts have suggested that the President will orchestrate declining rates until the election, even if rapidly expanding bank reserves would lead to an inflationary explosion in 1985. But many believe the American electorate has become too sophisticated to be fooled by such political chicanery.

More likely, the Federal Reserve will view any slowing of economic activity early this year as an opportunity to reduce the growth of monetary variables without generating upward pressure on interest rates. If a rejuvenated economic expansion begins to develop later in the year, the Federal Reserve then would be able to supply bank reserves to limit the upward movement of interest rates without creating a significant inflationary hangover in 1985. Recent Federal Reserve actions are consistent with this possibility.

Despite adjustments to an election environment, declining federal deficits and a slowing rate of economic expansion--as the economy completes its recovery and moves toward expansion--should create modest declines in all interest rates early in 1984. In the first quarter this year commercial paper rates slightly below 8%, a prime rate near 10%, and conventional mortgage rates in the vicinity of 12.5% (which would permit commercial mortgage rates of 13%) all are likely. Unfortunately, government deficits will become stuck in the vicinity of $160 billion after the first quarter, having declined from a horrendous $220 billion annual rate in the summer months of 1983.

Initially, the private economy will not be exerting increasing pressures upon credit markets. Early this year residential construction should slow until housing activity equals with housing demand (starts are expected to average 1.65 million in 1984). Also, some industries may fail to recognize that strong sales growth in a year of recovery largely represents refilling a depleted distribution pipeline. Those who assume that sales growth experienced during recovery can be maintained in the subsequent expansion will produce excess inventories, requiring some production curtailments.

This period of reduced economic growth should develop early in the year, causing gains in inflation-adjusted GNP of 4.5%, 3.3%, 3% and 4.8% during the year's four quarters. Upward interest rate pressures will begin to build as the year comes to an end. As 1984 ends, commercial paper will again be yielding slightly more than 9%, the prime rate will be pressing toward 11% and conventional mortgage rates will remain in the vicinity of 12.5%.

While interest rates will on the average be slightly lower in 1984 than in 1983, reduced interest rates will provide a much smaller contribution to cost reductions than in the previous year. Farm Problems

Prices received by farmers for products sold to food processors will rise sharply. In 1983 corn used for feed, consumption, and export totalled 7.5 billion bushels. Because of the drought and acreage reductions, the total amount of corn available this year is only 7.7 billion bushels. Since an estimated 750 million bushels are needed to maintain an adequate inventory, this means that less than 7 billion is available for all other purposes. Obviously, prices must rise sufficiently to reduce the normal use of corn.

The situation is similar, if more severe, in soybeans. Total use has averaged 2.1 billion bushels a year for several years, but drought has reduced the availability to 1.95 billion bushels. Some inventory also is necessary to provide processors with adequate supplies.

Price increases have already been substantial for oil products, such as margarine and cooking oil. Moderate price increases may also develop for baked goods, although the wheat supply is adequate. However, the primary consumers of corn and soybean meal are animals. Since low weight animals are not economical, corn and soybean usage can only be brought into balance with available supplies after the size of herds and flocks has been reduced.

Most of the reduction in poultry flocks occurred when last summer's heat suffocated birds and reduced egg production. However, the hog herds were 10% above the previous year and cattle herds were only 1% below the previous year when prices of feed grains accelerated by almost 40%. Intense slaughtering of animals reduced those herds in the fall, but the increased supply of meat resulting from the slaughters prevented food prices from rising.

Meat consumption is seasonally low in the winter months, but the impact upon the production of meat from the reduced herds should become apparent late in the spring. When the barbecue season arrives, production of meat should be sufficiently reduced to cut per capita meat consumption by 3%. This will occur even as rising employment will be raising the real purchasing power of consumers. As a result, consumer prices of meat products probably will rise at an annual rate of more than 12% in the latter half of 1984.

Of course, today's supermarket provides the consumer with much more than food products. These other commodities should not be experiencing price increases as rapidly as food items. Price increases for detergents and cosmetics should be less than 5% in 1984. Most of the automotive products, which include petroleum derivatives, may experience even lower price increases.

The consumer certainly will have the purchasing power to sustain significant growth in unit sales of merchandise during 1984. Employment is expected to increase by almost 3.5%. Although wage increases are expected to be only comparable to 1983 gains, overall earnings are expected to increase almost 10%. Rising Social Security taxes will lower the gains in personal income to only 9%, but consumer purchasing power will remain nearly 4% above inflation in 1984.

To be sure, supermarkets will need to work harder to retain their share of the consumer dollar during the year. Contrary to the pronouncements of the Department of Agriculture, food prices will be growing more rapidly than general prices in 1984.

Of course, the economy will continue to expand moderately. After adjustment for inflation, the GNP is expected to increase 5% in 1984. Economic activity may grow slowly in the spring and summer, but strong growth is expected to turn by the year's end.

If the prospects of modest consumer resistance to rising food prices and moderately slower volume growth in 1984 than in 1983 is disturbing, the grocery industry need only wait until 1985. By that time, the drought of 1983 will be a fading memory, food prices once again will grow more slowly than general inflation, and consumer grumbling about price increases once again will diminish. In the meantime, the challenges of 1984 will test everyone's management skills.
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Author:Ratajczak, Don
Publication:Progressive Grocer
Date:Feb 1, 1984
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