Why We Doubt the UK’s ‘Voluntary’ Grocery Price Caps Help

After another surge in food prices caused the UK’s April inflation to slow less than expected last week, it was a foregone conclusion that a government in desperate need of a polling boost would try to do something to “help.” That “something” has now become clear: The ever-reliable sources familiar with Downing Street’s plans have revealed that Cabinet ministers are putting the finishing touches on a plan to enact “voluntary” supermarket price caps. In our view, this is a counterproductive plan that, like all price controls, risks worsening the problem and making markets skittish. That wouldn’t be the biggest deal for global investors, considering price controls are just one variable and UK stocks are 4.3% of MSCI World Index market cap, but this narrative seems to be spreading across the Atlantic, a development we think is worth watching.^[i]

The push to cap prices follows several months’ worth of jawboning about “greedflation” from the Bank of England, politicians and interest groups. By their telling, with global food commodity prices and wholesale costs going down, there is no logical economic reason for prices at UK  grocery stores to continue rising. Hence, corporate greed must be food inflation’s driving force.

In covering this topic last month, we pointed out the actual reasons for sticky UK food prices. Local harvest issues were a big contributor. So is UK supermarkets’ tendency to ink long-term contracts with vendors, locking in higher costs for several months or more. Contracts in place now reflect higher food commodity prices last year. Eventually those will reset at today’s lower prices, enabling retailers to pass lower costs on to consumers, but it isn’t an overnight process. Lastly, for all the talk of grocers’ padding profit margins, the three largest publicly traded UK supermarkets’ gross margins have actually shrunk over the past year.^[ii] Not by a huge amount, but it does seem grocers aren’t passing all of their pain to consumers, contrary to the narrative at work here. 

But facts and politics rarely meet, so we have the UK government’s latest attempt to help households weather higher living costs. The same crew that gave Brits energy price caps that didn’t actually cap energy prices are now cooking up food price caps. Modeled after a French program enacted in March, if adopted, the caps would supposedly be narrow and voluntary, limited to a handful of basic goods that grocers would agree to sell at the lowest possible price. In France, it applied mainly to house-brand staples, and the government didn’t send out a price schedule. So, it seems innocuous. Except, “voluntary” isn’t totally voluntary when the government threatens to jack up grocery stores’ taxes if prices keep rising—which is what happened in France. To us, it seems more like a mafia protection racket.

As a general rule, price controls don’t work. They might seem to, at first, because the price stops jumping. But they usually create shortages since they destroy the incentive to boost production. Those shortages, in turn, lead to higher prices once the ceiling resets or bites the dust. In the end, prices likely end up higher than they otherwise would have been. After all, prices are a signal. When they rise, they tell producers to ramp up. Supply rises and eventually meets demand—stabilizing prices—or overshoots, creating surpluses that force prices lower. If you don’t buy that theory, think about strawberries for a minute. Early this spring, they were scarce and prices were sky-high, largely because heavy rains stamped out California’s crop. Farmers had to pull up their plants and start anew late in the growing season. They had an incentive to do so because they anticipated they could fetch a pretty penny for whatever they could bring to market. Had the Department of Agriculture capped prices, they might not have bothered. But the market stayed free, the farmers pressed on, and now we are enjoying a bumper crop of beautiful late-spring strawberries at bargain-basement prices because farmers have far more than they can handle. When we say prices are self-regulating, this is what we mean.

Hence, when news broke that the UK government was mulling food price controls, commentators and grocers lashed out, warning of shortages and rationing. In theory they are correct, but in reality the UK’s plans seem too squishy and limited to empty supermarket shelves. It is somewhat more likely that, to the extent capping prices drives losses on one set of necessities, grocers raise other prices to offset the effect, which further highlights the inanity of such policies. So we can see a case for the fear being worse than the reality. France’s large publicly traded supermarket has performed in line with the MSCI France Index since the government announced its price controls in early March, which likely speaks to the same thing.^[iii] So we mostly see the UK’s plans as a headache that won’t help tame inflation, not a profit-destroying wallop for global markets.

If price controls expanded to more industries and a much larger swath of the global economy, however, the risks for stocks could escalate. We don’t think this looks likely, but the greedflation narrative is now gaining ground in the US, so it bears watching. Keep an eye out, but for now, we think the sentiment surrounding price controls has probably overshot to the downside, preserving the wall of worry for what looks increasingly like a young bull market.