U.S. consumers have watched food and fuel prices eat away at their household budgets, and now those price hikes are spreading to other products - with the worst yet to come.
New York Federal Reserve Bank President William Dudley recently got a taste of public frustration with higher prices. He spoke to a crowd in Queens, New York on March 11 to tackle a mountain of food inflation questions. Dudley told the audience that while some prices are rising, other products are cheaper - like the Apple Inc.'s (Nasdaq: AAPL) latest iPad.
"Today you can buy an iPad 2 that costs the same as an iPad 1 that is twice as powerful," said Dudley. "You have to look at the prices of all things."
Dudley's comparison prompted one audience member to reply, "I can't eat an iPad."
Another asked Dudley when the last time was that he went grocery shopping.
Indeed, an affordable iPad will likely remain low on consumers' list of concerns. They are too busy deciding how to pay for gasoline and groceries.
Companies Pass On the Price Pain
The consumer price index (CPI) in February showed food-at-home prices rose 2.8% in the past year, and gasoline costs climbed a whopping 19.2%. Prices for all items rose 2.1%, but many experts consider real inflation closer to 8% -- or higher.
"My research suggests inflation is really running between 9% and 12%, which is more commensurate with what we all feel in our wallets every day," said Money Morning Chief Investment Strategist Keith Fitz-Gerald.
The producer price index (PPI), which tracks the price of goods before they reach consumers, also rose last month. U.S. wholesale prices were up 1.6% in February, doubling their increase in January and soaring past economists' estimates of 0.7%.
Higher wholesale prices are not always passed on to consumers. Retailers sometimes try to absorb the costs to keep shoppers buying their products. But with wholesale prices up 5.6% in the past year, and consumer prices only up 2.1%, businesses are running out of ways to avoid further price hikes. That means consumers have more price pain ahead.
"Price increases take some time to come through," John Ryding, chief economist with RDQ Economics, told CNNMoney.com. "But the idea that we'll dodge the prices this time around doesn't make any sense."
Wholesale food prices last month rose by 3.9%, the most since November 1974, and are up 7.3% in the past 12 months. Food prices are at their highest levels since the United Nations began tracking them in 1990.
Food prices hit their previous high in June 2008, but economists expect this current surge to be more permanent.
"The big difference today relative to the 2008 commodity rise is that underlying demand is significantly more robust. This means that price gains are more likely to stick," Joseph LaVorgna, chief U.S. economist for Deutsche Bank AG (NYSE: DB), wrote in a note.
Companies have seen shrinking profit margins as they pair record high commodity prices with higher shipping costs. They either have to find a way to balance the extra costs, or raise prices and risk losing cost-conscious consumers to other products. Businesses may be hesitant to raise prices while consumers are bargain hunting, but many are left with few other options.
"The possibility that it will be passed to the consumer is starting to grow," said Eugenio Alemán, senior economist with Wells Fargo Securities. "The U.S. economy is recovering and there is more consumption, leading firms to believe they can raise prices."
The price jumps already have started in many popular food chains:
Wendy's restaurants, part of Wendy's Arby's Group Inc. (NYSE: WEN), is only putting tomatoes on sandwiches per customer request. Starbucks Corp. (Nasdaq: SBUX) and Dunkin' Donuts have raised coffee prices as bean prices continue to surge. And Kellogg Company (NYSE: K) said it expects higher grain costs to push cereal prices up 3% to 4% this year.
Meanwhile, foodmaker General Mills Inc. (NYSE: GIS) said it expects inflation for food ingredients to climb higher this year than the 4% to 5% it previously forecast.
Analysts have long considered General Mills to be among the industry's best at handling higher commodity costs, but even that company's brass has said its shoppers won't be immune to the price squeeze.
"We need some list pricing (increases) and I think that our retail partners understand that," General Mills Chief Executive Officer Ken Powell said on a conference call.
Now consumers are starting to see more price hikes beyond the grocery store and the gas pump. February's CPI showed price gains in new vehicles, entertainment, medical care and airline fares.
Hanesbrands Inc. (NYSE: HBI) raised prices on many products last month and could do so again this summer. Cotton prices have hit record highs this year.
Appliance maker Whirlpool Corp. (NYSE: WHR) could push prices higher next month due to climbing steel costs.
Kimberly-Clark Corp. (NYSE: KMB) announced this week it will raise prices this summer in North America due to higher raw material and energy costs. U.S. consumers will see prices for products like Huggies baby wipes and diapers, Pull-Ups training pants and Goodnites youth pants go up 3% to 7%. Prices of Cottonelle and Scott bathroom tissue will also rise about 7%.
While many retailers admit that prices will rise in coming months, their desire to keep customers means steep bargains for consumers with the extra cash.
Kohl's Corp. (NYSE: KSS) plans to roll out more discount programs, like special discounts for shoppers over age 60.
"Apparel inflation is clearly real, but we believe we have had the time, the tools and the processes to work through it effectively and have a competitive advantage for both us and our consumer," said Kevin Mansell, chief executive of Kohl's.
Consumers Ready for Brewing Inflation Storm
U.S. consumers handle rising prices through a variety of tactics, such as stockpiling, sales hunting, or paring down to the bare minimum.
A survey released Monday by America's Research Group (ARG) showed about 75% of Americans were shopping less due to higher gas prices. Consumers are also cutting coupons and searching for bargains more than in prior months.
"What we are going to see happen is that consumers will try and cut back on all discretionary purchases, until finally they are going to have to make a decision at some point: what do I really have to give up?" said ARG President Britt Beemer.
Economists at Morgan Stanley (NYSE: MS) and Deutsche Bank AG (NYSE: DB) cut consumer-spending forecasts based on data showing U.S. households are using extra cash to boost savings to prepare for higher food and fuel prices, a trend likely to continue through 2011.
"If gasoline prices continue to rise, this would mean less disposable income for other retail sectors," Michael McNamara, vice-president of research and analysis for MasterCard Advisors SpendingPulse, told The Financial Times. "If consumers cut back on driving, this could put pressure on categories such as the travel industry and some segments of the restaurant sector, while benefiting online retail."
Consumers this year have already turned to bulk stores to deal with higher prices. Costco Wholesale Corp. (Nasdaq: COST) sales rose 11% in the second quarter to $20.45 billion. BJ's Wholesale Club reported a 7.4% sales increase to $2.9 billion with same store sales up 3.8%.
BJ's Chief Executive Officer Laura Sen said shopper traffic is up, especially at store locations with gas pumps.
"We also see that we've got some improved performance in member sign-ups versus a year ago, in clubs that have gas," Sen told The FT. "We see this as one of our best marketing tools, especially in a rising-price environment."
U.S. consumers are likely to hit discount chains more to trim shopping budgets. This should push some heated competition among retailers.
"Wal-Mart has a new enemy called the dollar stores," said Beemer.
Family Dollar Stores Inc. (NYSE: FDO) saw second quarter earnings rise 8.3% to $2.09 billion. Comparable-store sales increased 5.1%.
"Sales (at discount retailers) are fairly steady and are selling a lot of consumable products and a lot of necessities," FBR Focus Fund portfolio manager Brian Macauley told Reuters.
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