London: Food prices, historically as changeable as the weather, are often put to one side when central bankers and economists gauge inflation, but soaring prices for everything from corn to milk are forcing a rethink.
Calculations of ‘core´ inflation strip out food and energy prices, seen as volatile and therefore liable to skew any snapshot of consumer price levels. But some analysts now argue that a steep climb in the cost of food worldwide in recent months could be permanent, or at least long lasting.
Merrill Lynch has even coined a term to capture the phenomenon of food prices forcing up consumer prices more broadly: “agflation.”
Corn prices are at 10-year highs, pushing up the cost of feed for livestock and therefore meat as well. Wheat and dairy prices are also up across the board.
The implication for global growth is potentially serious if the inflationary threat convinces central banks to set interest rates at higher levels than they would otherwise do.
Few countries, developing or developed, seem immune.
In China, inflation was 3.0% in April, just off a two-year high, driven by food price inflation of 7.1%.
US food prices, normally in line with broader price levels, are expected to outpace the general inflation rate by as much as 2 % for the next two years.
Inflation in Turkey has jumped to 10.7%, partly the result of food prices rising four times faster than a year ago.
A leading culprit in Britain’s 3.1% inflation in March, famously beyond the Bank of England’s target zone, was food prices, up nearly twice as much.
Volatile or permanent?
Forecasting the future of food prices is more the realm of the agronomist than the economist. But enough evidence has now accumulated for economists to contemplate ‘what-if´ scenarios of persistently higher food prices and their impact on inflation.
“The risk is that you call something temporary or volatile, which turns out to be structural,” said Lex Hoogduin, chief economist at Robeco in the Netherlands.
Hot, dry weather in many parts of the world augurs poorly for this year’s harvest -- that is seasonal volatility.
However, there are also shifting demand and supply patterns, which could amount to structural change.
Demand for agricultural goods has spiked because of the fast developing bio-fuels industry and bigger appetites in China as it continues to surge. And unlike past periods of rising food prices, farm experts say there is less spare capacity of cultivatable land.
Vigilance, not immediate action, is the likely response of most central banks.
“I don’t think you should react initially, say in the first few months, to these kinds of surprises,” said William Gavin, vice president at the Federal Reserve Bank of St Louis, who has researched the effects of food inflation.
“But once they become embedded you have to react to them.”
Some analysts are confident that the agricultural market will respond to the incentive of higher prices and begin to produce more, putting a lid on agflation.
“You have all sorts of forces going in opposite directions,” said Danny Gabay, managing director at Fathom Financial Consulting and former economist at the Bank of England.
Advances in the science of genetic modification, admittedly controversial, could increase farming yields for crops from wheat to tomatoes. And though water and land supplies have grown tighter with the global population explosion, some suggest there is still more room for farming, such as Brazil’s grasslands.
Where it hurts
If agflation does truly take off, it would hurt most in developing countries, because of the relatively large portion of personal expenditures their residents devote to food.
This is reflected in the heavy weighting given to food in the commodity baskets used to measure inflation in developing countries.
Food makes about 10% of the US consumer price basket. In South Africa it carries a 25% weighting. It is 50% in the Philippines.
That said, large exporters of foodstuffs stand to benefit just as Venezuela and Nigeria have from more expensive oil.
Although the developing world would bear the brunt of agflation it could ripple through to consumers in wealthier countries. For example, costlier food in China could lead to increasing wage demands there -- and, consequently, more expensive made-in-China goods for shoppers overseas.
Such an import price shock is the main way that Alan Castle, chief UK economist at Lehman Brothers, thinks the food factor could impinge on medium-term inflation forecasts.
But before adjusting any forecasts Castle, like most analysts, will wait to be certain that food inflation is more than a passing phase.
He points to British food prices, which appear to follow a pattern of peaking every five years or so before levelling off.
“We may have been here before,” he said.