The extreme and rapid negative impact of the COVID-19 pandemic on the global economy in 2020 has been well documented (for example, in Market Bulletin issue 203). Economies around the world were hit with high unemployment rates as whole industries were shut down overnight. As a result, many governments implemented stimulus packages to help weather the storm and help their citizens to, at least financially, survive the pandemic. These vast economic movements – first decline, then swift rebound – have amounted to unprecedented, and quickly changing, conditions that central banks are under pressure to respond to.
This Market Bulletin will summarise these conditions in the top markets for Australian wine: Australia, the United Kingdom (UK), the United States (USA), and Canada, which together account for 80 per cent of the volume of Australian wine sold. It will then look at past and current data to see if any insights can be gained about how this environment is likely to affect wine consumption.
Current state of affairs in key markets
This yo-yo of economic performance has caused inflation to rise steeply in many markets, as consumers spent their funds on goods rather than services, and the cost of those goods increased due to factors including the global shipping issues. Figure 1 shows how inflation has reached levels of at least 6 per cent in all four of the key markets analysed. In addition, the annual GDP growth is much less than inflation and is on a downward trend. One positive factor is unemployment, which remains low, at around 3.5 per cent in Australia, the UK, and the US.
Figure 1: Annual GDP growth, inflation, interest, and unemployment rates in key markets
Source: Trading Economics, as at September 2022
One method to temper inflation is for central banks to raise interest rates. Raising interest rates can cool down an overheated economy by making saving look more attractive, loans less so, and decreasing disposable income – thus bringing down demand for goods and services. During COVID-19, and the most recent years before it, interest rates were at historical lows in key markets. The response by central banks in the markets shown in Figure 1 has been fairly unified – quickly raising interest rates (to an average of 2.75 per cent across the four markets, as at September 2022) in order to bring down inflation as quickly as possible.
How does inflation affect the price of wine?
Can we expect the same price increases in wine as other goods? The data from Australia so far points to ‘no’. Figure 2 shows the percentage price increase compared to the same quarter in the previous year of wine, beer, spirits, and ‘all goods’ sold in Australia. While there is a lot of variation, the change in price has stayed within a predictable range, except for spirits in 2008 (as a result of the introduction of the alcopop tax), and ‘all goods’ in the most recent quarters. Importantly, it seems that the alcoholic categories have not risen in price along with the rest of the goods in the economy.
Figure 2: Consumer Price Index, Australia – alcoholic drink categories versus all goods
(Source: Australia Bureau of Statistics)
Data from IRI in the UK shows a similar trend: alcohol shows the lowest price increases in Fast Moving Consumer Goods (FMCG), due at least partly to competitive pressure. They report that wholesale alcohol prices grew by 1.6 per cent in the July 2022 quarter compared to the same quarter in the previous year; this price change consisted of a 3.9 per cent actual price increase, which was partially counteracted by consumers switching to cheaper products (decreasing the average price by 2.3 per cent).
This may not always be the case; price increases could just be delayed in wine compared to other goods as there is only one grape intake and vintage per year. The cost of producing wine is growing as the cost of inputs – labour, packaging, energy – increase, and some of this cost may eventually be passed on to the consumer.
Multiple studies are showing that low-income consumers are disproportionally trading down as prices rise. IRI reports that, in the United States, FMCG stores in low-income areas are seeing more consumers trading out of “indulgence” categories such as candy, seafood, and energy drinks.
Another study, also from the US and conducted in July 2022, found that 20 per cent of those surveyed who earn more than $100,000 per year said they drank more alcohol in the past month, while only 12 per cent of those earning less than $50,000 reported doing the same. In fact, 37 per cent of those in the lower income bracket drank less alcohol. The study also presents the view that the continued strong spending by high-income earners is so far masking the decline in the consumption by low-income earners. But if the expendable income of all consumers keeps declining, premium categories will also start to be affected.
In the US on-premise, a quarter of consumers have reported going out less often than usual in the past 3 months, with the primary reason for doing so being cost of living increases and higher prices. Further, 7 in 10 consumers have noticed price increases in bars/restaurants and a third of these consumers have been purchasing less drinks and visiting the on-premise less often (CGA).
What if a global recession develops?
As central banks increase interest rates, the danger is that demand will be suppressed so far as to throw economies into recession. In Australia, it has been 22 years since these levels of interest rates increases have been experienced – hitting the bank accounts of homeowners very hard and pushing down consumer confidence (IRI MarketEdge). In the US, they have already had two consecutive quarters of negative economic growth. The World Bank has released a study indicating that central banks are expected to raise interest rates to 4 per cent by early 2023, and yet inflation is only expected to be curtailed to 5 per cent by these moves. In order to bring inflation back to an ideal level, an additional increase of 2 percentage points could be needed – and they project that this will dampen global GDP growth to just 0.5 per cent in 2023.
So how isolated is wine consumption from the effects of a recession? Looking at IWSR data for US wine consumption during the 2008–09 Global Financial Crisis (GFC) could give some clues.
Figure 3: Year-on-year growth rates of US wine consumption by volume and value
(Source: IWSR)
Figure 3 reveals that, during 2008, the volume of wine consumption in the US grew by 1.1 per cent, while value declined by 1.5 per cent. However, value made a strong rebound in the subsequent years, growing by 8 per cent in 2011, while volume made a more gradual recovery.
The decline in the value of wine consumption was driven by a sudden drop in the growth of premium wine (US$10 per bottle and above). In 2007, before the GFC hit, the volume of premium wine consumed grew by 9 per cent; this fell to a decline of 1 per cent in the next year (see Figure 4). However, the growth of premium wine recovered relatively quickly, growing by 13 per cent in 2011, nearly as much as it grew in 2006. This indicates that, while premiumisation might take a temporary hit, it tends to recover quite quickly once the recession has passed.
In contrast, the growth rates of commercial wine hardly changed during this period. IWSR reports that commercial wine tends to stay on its growth trajectory during recessions. What remains to be seen is how commercial wine will grow during any potential recessions in 2022–23 as it has been on a downward trajectory, declining by 2 per cent on average per annum in the past five years.
Figure 4: Year-on-year growth rates of premium and commercial wine in the US
(Source: IWSR)
The silver lining?
One positive outcome from all this economic turmoil is that the Australian dollar has fallen in value compared to the US dollar, and this is good news for Australian wine exporters. As seen in Figure 5, a lower exchange rate means that Australian wine will be priced more competitively in overseas markets, keeping all other things constant. For example, in 2012, a product leaving Australia worth A$10 per litre FOB would end up selling for an estimated US$27 per bottle thanks to the AUD being at parity with the USD. Comparatively, that same bottle of wine could end up on the shelf at an estimated US$19 per bottle, with an exchange rate of 0.65 AUD/USD. This advantage could help Australian wines stay competitive amongst any future price increases.
Figure 5: Retail USD per bottle of wine shipped at A$10 per litre FOB, by exchange rate
(Source: Wine Australia. US retail price is derived from the average value FOB, plus Wine Australia estimates of transportation costs, taxes, distributor and retail margins.)