Persistent Food Inflation Outpaces Overall Inflation, Linked to Tight Labor Markets. Labor-Intensive Processed Food Products Drive Grocery Price Increases Amid Rising Production and Distribution Costs. Continued Supply-side Pressure and Strong Home Food Demand May Sustain Elevated Grocery Store Prices.
Food inflation outpaces overall inflation despite slower price growth. Recent data shows food prices surging ahead of Consumer Price Index (CPI). Chart 1 highlights the disparity, with food inflation outpacing headline inflation. By March 2023, common food basket prices (green line) surged nearly 9% since early 2021.
The COVID-19 pandemic caused a significant shift in consumer food purchasing patterns and disrupted the equilibrium between supply and demand. As depicted in Chart 2, there was a substantial decrease in spending on food consumed outside the home (represented by the blue line) in early 2020. This shift was driven by the implementation of public health measures, which increased the demand for groceries (food at home) while reducing spending at restaurants and food service establishments (food away from home).
With the gradual easing of public health measures in 2021, consumer spending on food away from home experienced a rebound, surpassing its long-term trend (indicated by the dotted blue line) in real terms by 2022. In contrast, spending on food at home (represented by the green line) returned to its long-term trend (dotted green line) during the same period. These trends suggest a potential softening in demand for food at home. However, it is important to note that prices for food at home have remained persistently high, despite these shifts in consumer behavior.
The recent surge in food prices can largely be attributed to the tightness in the labor market. According to Chart 3, there has been a stronger correlation between labor market tightness and the Consumer Price Index (CPI) for food at home in the past two years. In the period from 2001 to 2020 (represented by blue dots), labor markets were less tight, and food inflation showed lower correlation with labor market conditions. However, since the beginning of 2021, there has been a noticeable increase in food prices, aligning with significant tightening in labor market conditions (represented by green dots).
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According to Chart 4, labor market tightness has resulted in more significant increases in average weekly wages in sectors related to food production and distribution since 2021. Recent studies indicate that salaries and benefits make up around 40 percent of the overall input cost for most food products, and this can have a notable impact on consumer prices. Additionally, higher wages can stimulate demand for certain food items at local stores, similar to how wages have driven demand for housing and subsequently led to rent inflation.
The combination of tight labor markets and wage growth has resulted in higher labor, production, and distribution costs, which have been passed on to consumers. According to Chart 5, processed foods accounted for nearly three-quarters of the price increase in food at home by the end of 2022. These processed foods are associated with labor-intensive stages further down the supply chain, including processing, wholesaling, and retailing. The correlation between food inflation and labor market tightness since 2021 can be attributed to supply-side cost pressures in an environment where consumers are willing to pay more for certain food items at grocery stores.
Despite some moderation in recent months, food inflation remains consistently elevated. The main driver of recent grocery price increases has been labor-intensive processed food items, which have experienced significant cost pressures in production. Tight labor market conditions have contributed to upward wage pressures and higher overall food production costs. If household budgets become more constrained and the demand for dining out continues to recover, some of the price pressures at grocery stores may alleviate. Additionally, tightening monetary policy could help alleviate food inflation by cooling the labor market, ultimately bringing headline inflation closer to the target.