A row erupted in mid-October between Tesco, the UK’s biggest supermarket, and Unilever, the Anglo-Dutch company. Unilever is the world’s largest consumer goods manufacturer with many well-known brands, including home care products, personal care products and food and drink. Unilever, which manufactures many of its products abroad and uses many ingredients from abroad in those manufactured in the UK, wanted to charge supermarkets 10% more for its products. It blamed the 16% fall in the value of sterling since the referendum in June (see the blog Sterling’s slide).
Tesco refused to pay the increase and so Unilever halted deliveries of over 200 items. As a result, several major brands became unavailable on the Tesco website. The dispute was dubbed ‘Marmitegate’, after one of Unilever’s products.
This is a classic case of power on both sides of the market: a powerful oligopolist, Unilever, facing a powerful oligopsonist, Tesco. With rising costs for Unilever resulting from the falling pound, either Unilever had to absorb the costs, or Tesco had to be prepared to pay the higher prices demanded by Unilever, passing some or all of them onto customers, or there had to be a compromise, with the prices Tesco pays to Unilever rising, but by less than 10%. A compromise was indeed reached on 13 October, with different price increases for each of Unilever’s products depending on how much of the costs are in foreign currencies. Precise details of the deal remained secret.
An interesting dynamic in the dispute was that Tesco and Unilever were acting as ‘champions’ for retailers and suppliers respectively. Other supermarkets were also facing price rises by Unilever. 
Their reactions were likely to depend on what Tesco did. Similarly, other suppliers were facing rising costs because of the falling pound. Their reactions might depend on how successful Unilever was in passing on its cost increases to retailers.
This example of ‘countervailing power’, or ‘bilateral oligopoly’, helps to illustrate just how much the consumer can gain when a powerful seller is confronted by a powerful buyer. The battle was been likened to that between two ‘gorillas’ of the industry. Its ramifications throughout industry will be interesting.
Podcasts and Webcasts
Tesco-Unilever row: Can unique shop explain ‘Marmitegate’? BBC News, Dougal Shaw (13/10/16)
Tesco, Unilever in Brexit price clash Reuters, David Pollard (13/10/16)
Brexit price-rise warning to shoppers BBC News, Simon Jack (10/10/16)
Tesco in Brexit Pricing Spat With Unilever Wall Street Journal (13/10/16)
Tesco battles Unilever over prices Financial Times on YouTube (14/10/16)
Tesco vs Unilever: Who won? ITV News, Joel Hills (14/10/16)
Articles
Tesco removes Marmite and other Unilever brands in price row BBC News (13/10/16)
Marmite Brexit Shortage ‘Just The Beginning’ Of ‘Gorilla’ Grocery Battle As Pound Slumps Huffington Post, Louise Ridley (13/10/16)
Unilever sales increase despite dozens of its brands being removed from Tesco shelves Independent, Ben Chapman (13/10/16)
Tesco-Unilever price row: Why pound value slump has caused Marmite to disappear from shelves Independent, Zlata Rodionova (13/10/16)
Tesco pulls Marmite from online store amid Brexit price row with Unilever The Telegraph, Peter Dominiczak, Steven Swinford and Ashley Armstrong (13/10/16)
Tesco runs short on Marmite and household brands in price row with Unilever The Guardian, Sarah Butler (13/10/16)
Tesco pulls products over plunging pound Financial Times, Mark Vandevelde, Scheherazade Daneshkhu and Paul McClean (13/10/16)
Brexit means…higher prices The Economist, Buttonwood’s notebook (13/10/16)
Tesco, Unilever settle prices row after pound’s Brexit dive Reuters, James Davey and Martinne Geller (14/10/16)
Questions
- To what extent can Tesco and Unilever be seen a price leaders of their respective market segments?
- What would you advise other supermarkets to do over their pricing decisions when faced with increased prices from suppliers, and why?
- What would you advise manufacturers of other consumer goods sold in supermarkets to do in the light of the Tesco/Unilever dispute, and why?
- What determines the price elasticity of demand for branded products, such as Marmite, Persil, Dove soap, Hellmann’s mayonnaise, PG Tips tea and Wall’s ice cream?
- What factors will determine in the end just how much extra the consumer pays when supermarkets are faced with demands for higher prices from major suppliers?
- Give some other examples of firms in industries where there is a high degree of countervailing power.
- What are the macroeconomic implications of a depreciating exchange rate?
- If, over the long term, the pound remained 16% below its level in June 2016, would you expect the consumer prices index in the long term to be approximately 16% higher than it would have been if the pound had not depreciated? Explain why or why not.
The IMF has just published its six-monthly World Economic Outlook. It expects world aggregate demand and growth to remain subdued. A combination of worries about the effects of Brexit and slower-than-expected growth in the USA has led the IMF to revise its forecasts for growth for both 2016 and 2017 downward by 0.1 percentage points compared with its April 2016 forecast. To quote the summary of the report:
Global growth is projected to slow to 3.1 percent in 2016 before recovering to 3.4 percent in 2017. The forecast, revised down by 0.1 percentage point for 2016 and 2017 relative to April, reflects a more subdued outlook for advanced economies following the June UK vote in favour of leaving the European Union (Brexit) and weaker-than-expected growth in the United States. These developments have put further downward pressure on global interest rates, as monetary policy is now expected to remain accommodative for longer.
Although the market reaction to the Brexit shock was reassuringly orderly, the ultimate impact remains very unclear, as the fate of institutional and trade arrangements between the United Kingdom and the European Union is uncertain.
The IMF is pessimistic about the outlook for advanced countries. 
It identifies political uncertainty and concerns about immigration and integration resulting in a rise in demands for populist, inward-looking policies as the major risk factors.
It is more optimistic about growth prospect for some emerging market economies, especially in Asia, but sees a sharp slowdown in other developing countries, especially in sub-Saharan Africa and in countries generally which rely on commodity exports during a period of lower commodity prices.
With little scope for further easing of monetary policy, the IMF recommends the increased use of fiscal policies:
Accommodative monetary policy alone cannot lift demand sufficiently, and fiscal support — calibrated to the amount of space available and oriented toward policies that protect the vulnerable and lift medium-term growth prospects — therefore remains essential for generating momentum and avoiding a lasting downshift in medium-term inflation expectations.
These fiscal policies should be accompanied by supply-side policies focused on structural reforms that can offset waning potential economic growth. These should include efforts to “boost labour force participation, improve the matching process in labour markets, and promote investment in research and development and innovation.”
Articles
IMF Sees Subdued Global Growth, Warns Economic Stagnation Could Fuel Protectionist Calls IMF News (4/10/16)
The World Economy: Moving Sideways IMF blog, Maurice Obstfeld (4/10/16)
The biggest threats facing the global economy in eight charts The Telegraph, Szu Ping Chan (4/10/16)
IMF and World Bank launch defence of open markets and free trade The Guardian, Larry Elliott (6/10/16)
IMF warns of financial stability risks BBC News, Andrew Walker (5/10/16)
Backlash to World Economic Order Clouds Outlook at IMF Talks Bloomberg, Rich Miller, Saleha Mohsin and Malcolm Scott (4/10/16)
IMF lowers growth forecast for US and other advanced economies Financial Times, Shawn Donnan (4/10/16)
Seven key points from the IMF’s latest global health check Financial TImes, Mehreen Khan (4/10/16)
Latest IMF forecast paints a bleak picture for global growth The Conversation, Geraint Johnes (5/10/16)
IMF Report, Videos and Data
World Economic Outlook, October 2016 IMF (4/10/16)
Press Conference on the Analytical Chapters IMF (27/9/16)
IMF Chief Economist Maurice Obstfeld explains the outlook for the global economy IMF Video (4/10/16)
Fiscal Policy in the New Normal IMF Video (6/10/16)
CNN Debate on the Global Economy IMF Video (6/10/16)
World Economic Outlook Database IMF (October 2016)
Questions
- Why is the IMF forecasting lower growth than in did in its April 2016 report?
- How much credibility should be put on IMF and other forecasts of global economic growth?
- Look at IMF forecasts for 2015 made in 2013 and 2012 for at least 2 macroeconomic indicators. How accurate were they? Explain the inaccuracies.
- What are the benefits and limitations of using fiscal policy to raise global economic growth?
- What are the main factors determining a country’s long-term rate of economic growth?
- Why is there growing mistrust of free trade in many countries? Is such mistrust justified?
The pound has fallen to its lowest rate against the euro since July 2013 and the lowest rate against the US dollar since 1985. Since August 2015, the pound has depreciated by 23.4% against the euro and 22.2% against the dollar. And since the referendum of 23 June, it has depreciated by 15.6% against the euro and 17.6% against the dollar.
On Sunday 2 October, at the start of the Conservative Party conference, the Prime Minister announced that Article 50, which triggers the Brexit process, would be invoked by the end of March 2017. Worries about what the terms of Brexit would look like put further pressure on the pound: the next day it fell by around 1% and the next day by a further 0.5%.
Then, on 6 October, it was reported that President Hollande was demanding tough Brexit negotiations and the pound dropped significantly further. By 7 October, it was trading at around €1.10 and $1.22. At airports, currency exchange agencies were offering less than €1 per £ (see picture).
With the government implying that Brexit might involve leaving the Single Market, the pound continued falling. On 12 October, the trade-weighted index reached its lowest level since the index was introduced in 1980: below its trough in the depth of the 2008 financial crisis and below the 1993 trough following Britain’s ejection from the European Exchange Rate Mechanism in September 1992.
So just why has the pound fallen so much, both before and after the Brexit vote? (Click here for a PowerPoint of the chart.) And what are the implications for the economy?
The articles explore the reasons for the depreciation. Central to these are the effects on the balance of payments from a possible decline in inward investment, lower interest rates leading to a net outflow of currency on the financial account, and stimulus measures, both fiscal and monetary, leading to higher imports.
Worries about the economy were occurring before the Brexit vote and this helped to push sterling down in late 2015 and early 2016, as you can see in the chart. This article from The Telegraph of 14 June 2016 explains why.
Despite the short-run effects on the UK economy of the Brexit vote not being as bad as some had predicted, worries remain about the longer-term effects. And these worries are compounded by uncertainty over the Brexit terms.
A lower sterling exchange rate reduces the foreign currency price of UK exports and increases the sterling price of imports. Depending on price elasticities of demand, this should improve the current account of the balance of payments.
These trade effects will help to boost the economy and go some way to countering the fall in investment as businesses, uncertain over the terms of Brexit, hold back on investment in the UK.
Articles
Pound Nears Three-Decade Low as May Sets Date for Brexit Trigger Bloomberg, Netty Idayu Ismail and Charlotte Ryan (3/10/16)
Sterling near 31-year low against dollar as May sets Brexit start dat Financial Times, Michael Hunter and Roger Blitz (3/10/16)
Sterling hits three-year low against the euro over Brexit worries The Guardian, Katie Allen (3/10/16)
Pound sterling value drops as Theresa May signals ‘hard Brexit’ at Tory conference Independent, Zlata Rodionova (3/10/16)
Pound falls as Theresa May indicates Brexit date BBC News (3/10/16)
The pound bombs and stocks explode over fears of a ‘hard Brexit’ Business Insider UK, Oscar Williams-Grut (3/10/16)
Pound Will Feel Pain as Brexit Clock Ticks Faster Wall Street Journal, Richard Barley (3/10/16)
British Pound to Euro Exchange Rate’s Brexit Breakdown Slows After Positive Manufacturing PMI Halts Decline Currency Watch, Joaquin Monfort (3/10/16)
7 ways the fall in the value of the pound affects us all Independent (4/10/16)
The pound and the fury: Brexit is making Britons poorer, and meaner The Economist, ‘Timekeeper’ (11/10/16)
Is the pound headed for parity v US dollar and euro? Sydney Morning Herald, Jessica Sier (5/10/16)
Flash crash sees the pound gyrate in Asian trading BBC News (7/10/16)
Flash crash hits pound after Hollande remarks Deutsche Welle (7/10/16)
Sterling mayhem gives glimpse into future Reuters, Swaha Pattanaik (7/10/16)
Sterling takes a pounding The Economist, Buttonwood (7/10/16)
Government must commit to fundamental reform The Telegraph, Andrew Sentance (7/10/16)
Data
Interest & exchange rates data – Statistical Interactive Database Bank of England
Questions
- Why has sterling depreciated? Use a demand and supply diagram to illustrate your argument.
- What has determined the size of this depreciation?
- What is meant by the risk premium of holding sterling?
- To what extent has the weaker pound contributed to the better economic performance than was expected immediately after the Brexit vote?
- What factors will determine the value of sterling over the coming months?
- Who gain and who lose from a lower exchange rate?
- What is likely to happen to inflation over the coming months? Explain and consider the implications for monetary and fiscal policy.
- What is a ‘flash crash’. Why was there a flash crash in sterling on Asian markets on 7 October 2016? Is such a flash crash in sterling likely to occur again?
In a recent blog, Falling sterling – bad for some; good for others, we looked at the depreciation of sterling following the Brexit vote. We saw how it will have beneficial effects for some, such as exporters, and adverse effects for others, such as consumers having to pay a higher price for imports and foreign holidays. The article linked below examines these effects in more depth.
Just how much the quantity of exports will increase depends on two main things. The first is the amount by which the foreign currency price falls. This depends on what exporters choose to do. Say the pound falls from €1.30 to €1.18. Do exporters who had previously sold a product selling in the UK for £100 and in the eurozone for €130, now reduce the euro price to €118? Or do they put it down by less – say, to €125, thereby earning £105.93 (£(125/1.18)). Their sales would increase by less, but their profit margin would rise.
The second is the foreign currency price elasticity of demand for exports in the foreign markets. The more elastic it is, the more exports will rise for any given euro price reduction.
It is similar with imports. How much the sales of these fall depends again on two main things. The first is the amount by which the importing companies are prepared to raise sterling prices. Again assume that the pound falls from €1.30 to €1.18 – in other words, the euro rises from 76.92p (£1/1.3) to 84.75p (£1/1.18). What happens to the price of an import to the UK from the eurozone whose euro price is €100? Does the importer raise the price from £76.92 to £84.75, or by less than that, being prepared to accept a smaller profit margin?
The second is the sterling price elasticity of demand for imports in the UK. The more elastic it is, the more imports will fall and, probably, the more the importer will be prepared to limit the sterling price increase.
The article also looks at the effect on aggregate demand. As we saw in the previous blog, a depreciation boosts aggregate demand by increasing exports and curbing imports. The effects of this rise in aggregate demand depends on the degree of slack in the economy and the extent, therefore, that (a) exporters and those producing import substitutes can respond in terms of high production and employment and (b) other sectors can produce more as multiplier effects play out.
Finally, the article looks at the effect of the depreciation of sterling on asset prices. UK assets will be worth less in foreign currency terms; foreign assets will be worth more in sterling. Just how much the prices of internationally traded assets, such as shares and some property, will change depends, again, on their price elasticities of demand. In terms of assets, there has been a gain to UK balance sheets from the depreciation. As Roger Bootle says:
Whereas the overwhelming majority of the UK’s liabilities to foreigners are denominated in sterling, the overwhelming bulk of our assets abroad are denominated in foreign currency. So the lower pound has raised the sterling value of our overseas assets while leaving the sterling value of our liabilities more or less unchanged.
Article
How a lower pound will help us to escape cloud cuckoo land, The Telegraph, Roger Bootle (31/7/16)
Questions
- What determines the amount that exporters from the UK adjust the foreign currency price of their exports following a depreciation of sterling?
- What determines the amount by which importers to the UK adjust the sterling price of their products following a depreciation of sterling?
- What determines the amount by which sterling will depreciate over the coming months?
- Distinguish between stabilising and destabilising speculation? How does this apply to exchange rates and what determines the likelihood of there being destabilising speculation against sterling exchange rates?
- How is UK inflation likely to be affected by a depreciation of sterling?
- Why does Roger Bootle believe that the UK has been living in ‘cloud cuckoo land’ with respect to exchange rates?
- Why has the UK managed to sustain a large current account deficit over so many years?
Since the Brexit vote in the referendum, sterling has been falling. It is now at a 31-year low against the US dollar. From 23 June to 6 July it depreciated by 12.9% against the US dollar, 10.7% against the euro and 17.0% against the yen. The trade-weighted sterling exchange rate index depreciated by 11.6%.
Why has this happened? Partly it reflects a decline in confidence in the UK economy by investors; partly it is in response to policy measures, actual and anticipated, by the Bank of England.
As far as investors are concerned, the anticipation is that there will be net direct investment outflows from the UK. This is because some companies in the UK are considering relocating part or all of their business from the UK to elsewhere in Europe. For example, EasyJet is drawing up plans to move its headquarters to continental Europe. It is also because investors believe that foreign direct investment in the UK is likely to fall as companies prefer to invest elsewhere, such as Ireland or Germany.
Thus although the effect of net direct investment outflows (or reductions in net inflows) will be on the long-term investment part of the financial account of the balance of payments, the immediate effect is felt on the short-term financial flows part of the account as investors anticipate such moves and the consequent fall in sterling.
As far as monetary policy is concerned, the fall in sterling is in response to four things announced or signalled by Mark Carney at recent news conferences (see Monetary and fiscal policies – a U-turn or keeping the economy on track?).
First is the anticipated fall in Bank Rate at the next meeting of the Monetary Policy Committee on 13/14 July. Second is the possibility of further quantitative easing (QE). Third is an additional £250bn of liquidity that the Bank is prepared to provide through its normal open-market operations. Fourth is the easing of capital requirements on banks (reducing the countercyclical buffer from 0.5% to 0%), which would allow additional lending by banks of up to £150bn.
Lower interest rates, additional liquidity and further QE would all increase the supply of sterling on the foreign exchange markets. The anticipation of this, plus the anticipation of lower interest rates, would decrease the demand for sterling. The effect of these supply and demand changes is a fall in the exchange rate.
But is a fall in the exchange rate a ‘good thing’? As far as consumers are concerned, the answer is no. Imports will be more expensive, as will foreign holidays. People’s pounds will buy less of things priced in foreign currency and thus people will be poorer.
As far as exporters are concerned, however, the foreign currency they earn will exchange into more pounds than before. Their sterling revenues, therefore, are likely to increase. They might also choose to reduce the foreign currency price of exports, thereby increasing the quantity sold – the amount depending on the price elasticity of demand. The increase in exports and reduction in imports will help to reduce the current account deficit and also boost aggregate demand.
Articles
Pound slumps to 31-year low following Brexit vote The Guardian, Katie Allen , Jill Treanor and Simon Goodley (24/6/16)
Sterling’s post-Brexit fall is biggest loss in a hard currency Reuters, Jamie McGeever (7/7/16)
Brexit Accelerates the British Pound’s 100 Years of Debasement Bloomberg, Simon Kennedy and Lukanyo Mnyanda (5/7/16)
Pound sterling falls below $1.31 hitting new 31-year low Independent, Hazel Sheffield (5/7/16)
Viewpoints: How low will sterling go? BBC News, Leisha Chi (6/7/16)
How low will the pound fall? Financial Times (7/7/16)
Allianz’s El-Erian says UK must urgently get its act together or dollar parity could beckon Reuters, Guy Faulconbridge (7/7/16)
What does a falling pound mean for the British economy? The Telegraph, Peter Spence (6/7/16)
Data
Spot exchange rates: Statistical Interactive Database – interest & exchange rates data Bank of England
Questions
- What determines how much the exchange rate depreciates for a given shift in the demand for sterling or the supply of sterling?
- Why might the short-term effects on exchange rates of the Brexit vote be different from the long-term effects?
- Why has the pound depreciated by different amounts against different currencies?
- What are likely to be the effects on the financial and current accounts of the balance of payments of the Bank of England’s measures?
- Find out what has happened to business confidence since the Brexit vote. What effect does the level of confidence have on the exchange rate and why?
A row erupted in mid-October between Tesco, the UK’s biggest supermarket, and Unilever, the Anglo-Dutch company. Unilever is the world’s largest consumer goods manufacturer with many well-known brands, including home care products, personal care products and food and drink. Unilever, which manufactures many of its products abroad and uses many ingredients from abroad in those manufactured in the UK, wanted to charge supermarkets 10% more for its products. It blamed the 16% fall in the value of sterling since the referendum in June (see the blog Sterling’s slide).
This is a classic case of power on both sides of the market: a powerful oligopolist, Unilever, facing a powerful oligopsonist, Tesco. With rising costs for Unilever resulting from the falling pound, either Unilever had to absorb the costs, or Tesco had to be prepared to pay the higher prices demanded by Unilever, passing some or all of them onto customers, or there had to be a compromise, with the prices Tesco pays to Unilever rising, but by less than 10%. A compromise was indeed reached on 13 October, with different price increases for each of Unilever’s products depending on how much of the costs are in foreign currencies. Precise details of the deal remained secret.
Their reactions were likely to depend on what Tesco did. Similarly, other suppliers were facing rising costs because of the falling pound. Their reactions might depend on how successful Unilever was in passing on its cost increases to retailers.
