What McDonald’s Icelandic exit means for Britain

In his 1999 ode to the joys of globalisation, ‘The Lexus and the Olive Tree’, Thomas L. Friedman claimed that “no two countries that both had McDonald’s had fought a war against each other since each got its McDonald’s”.

We don’t think that Iceland is about to declare war on Britain (though they could perhaps be forgiven for feeling a bit annoyed with us – we did freeze their assets using anti-terror laws, after all). But the implications of the country’s three McDonald’s branches shutting down hold some important lessons for the UK.

What’s behind McDonald’s exit from Iceland? Cost, pure and simple, says Lyst, the local franchise operator. The ingredients for hamburgers must be imported according to McDonald’s strict rules and regulations. And that’s become far too pricey.

With Iceland almost going broke last year, the currency imploded as overseas investors lost all confidence in the country. Since the end of 2007, the krona has halved in value against the US dollar. So Lyst has had to pay twice the price for its imports, and hasn’t been able to pass most of these higher costs onto its customers. Net result: a very nasty profit margin squeeze.

A similar, much more personal margin squeeze, is happening on a smaller scale in every Icelandic household. The krona’s drop means Iceland is currently battling an inflation rate of nearly 11%. But Icelanders’ wages are growing at just 1.9% year-on-year.

So what can we learn from this? Well, while sterling hasn’t suffered anything like as much as the krona, it’s been sliding while the Bank of England has printed more money (more pounds = lower price) and as our government debt has ballooned. The more the pound falls, the more our import costs climb.

And despite all the economists’ forecasts for UK deflation, it hasn’t happened yet. Britain’s consumer price inflation rate is still above 1%, while the ‘core’ rate, i.e. excluding food and energy costs, is running at 1.7%. With higher VAT likely to return soon, and as oil prices rise (see: The biggest threat to the recovery – the soaring oil price), UK inflation is very likely to rise in the coming months.

That won’t be fun for the average UK consumer. Unless you work in banking, your income is likely to rise more slowly than consumer prices. So you’ll have less ‘real’ money to spend. And if inflation does continue to tick up, interest rates could rise sooner than widely expected. That’s not good for the likes of house prices.

Our squeeze may not be as painful as the one the Icelanders are facing – we don’t think McDonald’s UK will shut down any time soon – but it’s yet another reason why the British consumer won’t be coming out of hibernation for quite some time. As we’ve been saying for a while, stay out of cyclicals and stick with defensives (see: What BP’s results tell us about the state of the economy).