‘Deflation is coming – retailers must be alive to the risks’

Inflation has been making headlines for more than a year but retailers now need to be alert to the risks of deflation, warns True’s Matt Truman

‘Deflation is coming – retailers must be alive to the risks’

Matt Truman / Opinion / 16 Aug 2023

Originally published by Retail Week.

Inflation has dominated the economic and political debate over the last 18 months.

The phrase ‘cost-of-living crisis’ began to gain prominence as fuel and energy prices spiked following Russia’s invasion of Ukraine.

According to Google, peak use of the term came towards the end of last year as further categories, notably food, experienced sharp price increases.

As 2023 has progressed, there has been gradually diminishing focus, though searches related to the cost of living remain well above the levels of early 2022 and, for example, the BBC retains a section of its website devoted to the cost of living (having fairly recently removed a similar section devoted to Covid-19).

As we stand, inflation has begun to recede from the peaks of last year’s fourth quarter – the most recently reported consumer prices index (CPI) data showed prices rising by 7.9% versus the same period in 2022, down from over 11% in October 2022.

While prices aren’t yet falling, the rate of increase is moderating and that is likely to continue over the months ahead. The Office for Budget Responsibility forecasts CPI will fall to 2.9% in quarter four this year, dip below the Bank of England’s target rate of 2% in the first quarter of 2024 and be broadly flat by 2025.

If this sounds like good news, it is. Inflation is often described as a ‘silent killer’ as it erodes purchasing power. UK consumers have experienced one of the sharpest contractions in their real incomes in history over the last two years. Does that mean retailers and consumers can start to relax? Sadly not.

Managing inflation is a complex and uncertain process, subject to multivariant external factors. Central banks in general, and the Bank of England especially, are judged to have initially underestimated the threat of inflation, perhaps anesthetised by a protracted period of stability in pricing and a preeminent focus on stimulating economic growth in the 15 years since the global financial crisis and the more recent challenge of Covid-19.

After belatedly recognising the challenge, the BoE has moved more forcibly with the Bank Rate of interest rising 14 times (and by over 500bps) since the end of 2021. The impact of this is uncertain, with economists generally estimating that increases in policy rates take around 18 to 24 months to fully affect economic activity.

In other words, it’s plausible the effects of tightening monetary policy have yet to be felt. Could the Bank have gone too far already? Possibly.

New focus

There are deflationary forces at play in the global economy, including but not limited to interest rates. Energy prices are lower than their peaks, food commodity prices are also lower than a year ago and China is edging close to deflation.

For the UK, sterling has bounced by around 20% against the US dollar since its nadir in September 2022 – a significant factor for a country with a structural trade deficit. The labour market, supported by supply constraints, has begun to show signs of softening – there are almost 300,000 fewer job vacancies in the economy than in mid-2022 and unemployment, though still at historically low levels, has edged up by 200,000 over the same period.

Retailers and brands need to be alive to the risk of deflation. From a period of intense focus on mitigating cost price increases, attention may need to shift to an environment of soft demand and falling competitor prices. The ‘premiumisation’ trend of the last decade may expose chasms in brand value propositions that could drive this deflationary catchup harder and faster than many perceive.

For the retail leaders we work closely with, we’re encouraging them to address the following questions: how can you be ahead of the cost curve, optimising faster and offering better value to your customers? How do you retain brand integrity in a phase of falling prices? What mechanisms can be deployed to reward loyalty and purchase frequency when delaying conversion becomes the logical choice for consumers? How can your P&L cope with both value and volumes under pressure? How should you think about capital allocation when prices are likely to be lower in the future? Finally, can your capital structure cope with deflation when coupled with decade-high interest rates?

There is no certainty but we may be approaching a critical inflection point in consumer market dynamics. If so, it will require different strategies and tactical playbooks to thrive. Don’t let it come as a surprise to your business.

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