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Low food inflation tightens squeeze on Europe's grocers

Fruit and vegetables are seen for sale in Soho's Berwick Street Market in central London May 17, 2011. REUTERS/Paul Hackett

By Emma Thomasson and James Davey

BERLIN/LONDON (Reuters) - Subdued food price inflation in Europe is unlikely to pick up any time soon, adding to the pressure on mainstream grocers as they struggle with changing shopping habits and competition from discounters.

Prices paid in Europe for fast-moving consumer goods rose at their slowest pace since 2010 in the third quarter, and fell in Spain, France and Italy, according to consumer data firm Nielsen, weighing on retailers' revenues and share prices.

The cost of fresh fruit and vegetables in particular has tumbled due to bumper harvests, a surplus caused by Russia's ban on food imports from the West, currency effects and fierce competition among grocers, stoked by the advance of discounters.

Falling inflation has laid bare problems supermarkets were already facing as shopping habits shift. After decades investing in large out-of-town sites, grocers are struggling to adapt to more fickle consumers, who like to hunt for a bargain while also demanding more convenience stores and online shopping.

"For a few years, those underlying challenges ... were partially masked by inflation which meant (grocers) still had absolute top line growth," said Will Hayllar of OC&C Strategy Consultants. "As that inflation has stabilized, the true picture of what's going on beneath has become more apparent."

There is little sign of imminent relief, especially as oil prices -- a key input cost for farmers -- have dropped by a third since June, although potentially easier monetary policies and a weaker euro and sterling could help rekindle inflation.

"Harvests this year have been pretty good. So you would expect that deflationary environment to exist for at least the next 12, probably 18 months," Mike Coupe, boss of UK grocer Sainsbury's, said in a recent results presentation.

Low food inflation is toughest for mid-market players such as France's Carrefour and Britain's Tesco as it makes it harder for them to pass on rising wage and rental costs to shoppers, squeezing their profit margins.

LOW INFLATION HELPS LOW-WAGE PLAYERS

"Discounters have less wage impact, that is why it is a competitive weapon," said Bernstein analyst Bruno Monteyne, a former senior Tesco supply chain executive.

"Low food inflation is good for the low-labor guys," he said, referring to the fact discounters employ fewer workers.

The rise of discounters such as Germany's Aldi and Lidl and shoppers' heightened price sensitivity since the financial crisis has meant supermarket groups are struggling to keep any benefits from lower commodity costs for themselves.

"If you looked at 2008, you’ll have seen an impact of some retailers taking advantage of price inflation through commodity price falls ... that's not a game we're going to play," said Andy Clarke of Asda, the British arm of Wal-Mart.

Asda, which has lower wage costs than its main rivals, was the first of Britain's leading grocers to cut prices, helping it stem the flow of shoppers to discounters.

Carrefour, Europe's biggest retailer, said cheaper fruit and vegetables -- which make up 6 percent of sales in hypermarkets and 8 percent in supermarkets -- dragged down quarterly sales.

Ahold, meanwhile, said the Russian import ban contributed to Dutch fruit and vegetable prices falling by 6-7 percent in the third quarter, although it sees that effect abating and has been helped by its exposure to the inflationary U.S. market.

Executives expect the world's growing population to eventually prompt a recovery in global food prices, even if European price wars could still intensify.

Lower prices are already helping sales volumes grow at their fastest pace since 2011, according to Nielsen, which expects volumes to rise further in the first quarter of 2015.

A return of food inflation could drive a recovery in the sector, now the cheapest it has been relative to the broader market in 10 years, trading on 12-13 times forward earnings.

"The last few times inflation was at these levels, the sector re-rated over the subsequent 12-18 months relative to market," said Citi analyst Pradeep Pratti.

"We are getting closer to the point where a sector re-rating is increasingly looking likely."

(Additional reporting by Robert-Jan Bartunek in Brussels, Martinne Geller in London; Editing by Mark Potter)

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