Food Prices Are New Inflation Threat for Governments and Central Banks

With food commodity prices down, widening profit margins might explain why consumers are paying more

Energy prices are falling back more than a year on from Russia’s invasion of Ukraine. But the other big cost of the war for households around the world continues to rise: food

In 12 months through March, prices of food, alcohol and tobacco were up 15.4% in the eurozone, while energy prices were down 0.9%. Food prices were up 10.2% in the U.S. in the 12 months through February, well ahead of energy at 5.2%.

Most economists expect to see a cooling of food prices over coming months. But it is unclear why they rose so much to start with. In world commodity markets, which set the prices received by farmers, food prices have been falling since April 2022. In most countries, food makes up the largest share of households’ budgets.

There are typically lags between movements in the prices farmers receive and the prices households pay. Raw commodity costs are just one part of the final price—consumers are also paying for processing, packaging, transport and distribution. Still, the length of the current lags, and the size of the gap between the farm and the dining table, has led some economists to see other forces at play: Businesses in the food-supply chain might have raised their prices more than needed to cover higher costs.

“The only way to explain this in relation to what we’ve seen in some of the commodity price indices for food is that margins are being expanded,” said Claus Vistesen, an economist at Pantheon Macroeconomics.

Some rate setters at the European Central Bank are now also looking at the inflationary potential of widening profit margins, with Fabio Panetta, a member of the ECB’s executive board, warning of a “profit-price spiral.”

“Opportunistic behavior by firms could also delay the fall in core inflation,” Mr. Panetta said in a March speech.

Russia’s invasion of Ukraine triggered a jump in the prices of globally traded food staples. Both are major exporters of grains and the raw materials needed to make fertilizer.

In March 2022, an index of food prices compiled by the United Nations that includes cereals, vegetable oils, sugar, meat and dairy products hit its highest in more than half a century of records.

It stayed near that level through June, then fell sharply in July and has been declining since, by 18.7% in February from its peak. By contrast, the prices paid for food in both the U.S. and European Union have kept rising.

European governments are getting worried.

Their primary concern following Russia’s invasion was to protect households from energy costs. Many enacted costly price caps, both to limit hardship during the winter and maintain voter support for sanctions against Russia and military and financial aid to Ukraine.

Food initially attracted less attention, in part because its price rose less than that of energy. That has changed in recent months. Already facing protests against its pension overhauls, the government of French President Emmanuel Macron last month sealed an agreement with leading retailers to keep food prices low.

“We are perfectly aware that today, what worries French men and women, what worries households, what worries families, what makes their daily life difficult, is the increase in daily prices, rising food prices,” said French Finance Minister Bruno Le Maire.

Mr. Le Maire said this agreement, which will last for three months through June, will involve a reduction of “several hundred million euros” in the profit margins of food suppliers.

There is some evidence that profit margins at food suppliers have risen since the start of the Covid-19 pandemic. According to economists at ING Bank, margins in Germany’s agricultural sector (which excludes manufacturers of packaged food and retailers) rose by 63% between the end of 2019 and the end of 2022, almost entirely because of higher profits rather than higher wages.

“The rise in price margins in the agricultural sector, the construction sector, and in the trade, transportation, and hospitality sector can be mainly explained by an increase in profits, and is thus not due to higher energy and commodity prices,” wrote economists at ING in a note to clients.

In Europe, profit margins across the whole of the economy are on the rise. The EU’s statistics agency Wednesday said the share of the operating surplus that was accounted for by profits rose to 42% in the final quarter of last year, the highest proportion since 2007. By contrast, the share going to workers fell slightly. In the U.S., profit margins remained near record highs in the fourth quarter, although they were down from the third quarter.

High food prices are also a problem for central banks. Most look to core inflation, which excludes food and energy, for underlying inflation trends. But they recognize headline inflation, which includes food and energy, can affect public expectations. Food is the one good that most households buy every day. That could lead workers to negotiate higher wages, which might feed back onto prices.

Whether food prices have risen because of weather, war or profit margins, central banks might have to respond with higher rates than otherwise, the Bank of England’s chief economist, Huw Pill, said in a speech Tuesday. “Persistent deviations of inflation from target, even if stemming from what are fundamentally a series of transitory inflation shocks, might prompt changes in behavior that generate more long-lasting inflationary dynamics,” Mr. Pill said.