The strengthening of non-European markets and general secure consumer confidence are also predicted for next year.
"Passing on food price increases to customers might be tough to achieve at a time when purchasing power is stagnating in Western Europe and the Russian and French governments are officially advocating low prices," said Standard & Poor's credit analyst Nicolas Baudouin.
"At the same time, many European players will need to focus on managing challenging expansion projects in emerging markets."
The overall outlook is one of stability and, from a business standpoint, Standard and Poor's expects most retailers to report satisfactory results for 2007.
Inflation to dent profitability
Prices for branded products have risen since April. However, the most significant hikes are expected to surface in 2008 when the results of current negotiations materialise. Inflation is expected to spread and this could dent operating margins.
Oil prices are now reaching around $100 (€67) per barrel causing the price of raw materials to rise, and leaving few businesses unaffected.
The higher cost of raw materials affects every process in the food industry, with the increased price of feed getting transferred from farmers onto ingredients' producers, then onto manufacturers and retailers. Meanwhile, poor weather this year has destroyed stock and affected production.
Companies have been facing the dilemma of whether they should increase retail prices, or swallow the costs themselves. UK supermarket Asda declared it would swallow many of the costs, as it was still committed to keeping consumer prices low.
Meanwhile, Germany-based retailer Metro took Kellogg's products off its shelves earlier this month after the cereal company attempted to pass on higher commodity costs through price hikes.
Growing non-European markets
Western European markets are mature with limited growth prospects and high competition. Consequently, most European retailers are striving to expand in Eastern Europe and emerging markets.
Meanwhile, countries with rising markets are growing quicker, with China having the largest growth prospects. While international expansion reduces dependence on home markets, it also adds volatility, which can be very high in the newer markets.
It also requires high levels of capital expenditures, which constrain free cash flow generation.
Trade with China has increased by 150 per cent, making it Europe's second trading partner after the USA, according to data released by the statistical office of the European Communities . Products produced there often come at a lower cost, piling pressure on European companies to cut their prices.
At the same time, countries such as China and India have adopted increasingly Westernised diet trends, therefore fuelling the need for trade and adding to competition.
Consumer confidence
Consumer confidence is stable overall, but not uniform across Europe. Consumer confidence in France has dropped considerably. The French National Institute for Statistics and Economic Studies found that consumer confidence there has deteriorated to -28 on the back of economic pessimism.
Meanwhile, consumer confidence is comparatively stronger in the UK and Germany.
Other key trends in European retail predicted for 2008 are an increased chance of acquisitions and the possibility of regulatory changes in France.
