Agflation could be as big a concern as global warming
25/07/2007
Around this time of year, Britain’s official inflation measures normally enjoy a seasonal fillip. It comes from lower food prices as summer produce floods into the shops. But since food comprised such a small part of the inflation basket, little official attention was traditionally paid to these changes in the price of food. All that, however, has now changed.
Back in March, analysts were already picking up on a persistent rise in the price of food and food raw materials. It formed part of a developing picture of rising food prices worldwide. Now, any hopes that Britain’s inflation rate might enjoy a respite through a good summer harvest has disappeared under flooded fields and a summer deluge that exceeds previous monsoon years such as 1956 and 1947.
Virtually every product, ranging from bread and dairy products through to livestock, has been badly affected by the exceptional wet weather. But even before the onset of the rains, rising prices have been of increasing concern. Earlier this month, Nestlé, the world’s largest food company, warned that prices were set for a period of “significant and long-lasting” inflation. Corn prices have risen by about 60% and wheat by 50% over the last 12 months due to rising demand from India and China and the increasing use of crops for biofuels.
The price of wheat has flown up by 53% since March last year to £130 a tonne. While Britain has suffered a monsoon summer, a key factor driving prices here has been a dearth of moisture in Australia, which has endured one of the worst droughts in its history.
Global corn stocks have fallen to their lowest levels since modern records began as ethanol plants consume an ever-growing share of output and demand balloons in Australia. China and Russia have also been reporting sharp rises in food prices, adding to fears that global food abundance may be coming to an end.
The phenomenon of high, persistent and continuing rises in food prices has even brought forth a new term in economics: agflation. And it is the behaviour of food prices – an inflation that none of us can avoid – that some believe could rival global warming as the biggest single concern on the planet.
Jose Rasco, an analyst at Merrill Lynch, says: “Given the expanding constraints on food supply, the changing demand for food and the entrance of the energy business as mass consumers of food products, it is not surprising to see food prices putting upward pressure on overall inflation.”
According to the International Monetary Fund, the green boom could see prices start following crude oil. “Rising demand for biofuels,” it warns, “will likely cause the prices of corn and soya bean oil to rise further, and to move closely with the price of crude oil as has been the case with sugar.”
Wheat shortages are emerging in countries such as India, which has become a net importer for the first time since 1975. China is expected to become an importer of corn by late 2008. Supply is diminishing in the US, source of 70% of the world’s supplies. The US has switched some 20% of its harvest to ethanol as part of its drive to cut dependence on oil from the Middle East. The figure was just 4% in 2000.
Earlier this month, the European Commission’s dairy management committee decided to cut export subsidies on milk products to zero. It’s the first time this has happened in the 40-year history of the Common Agricultural Policy, a protectionist scheme that uses taxpayers’ money to support Europe’s farmers. The reason is that, since February, the world price for skimmed milk has rocketed by almost 60%, while butter is up 28% and cheese 16%.
After three years of steadily falling milk prices (3% last year) and a bigger-than-ever squeeze on margins for hard-pressed dairy farmers, the wholesale price of milk has doubled over the past 12 months.
How might this impact on the UK’s inflation and monetary policy? The situation is not as extreme as New Zealand, which cited a 60% rise in milk prices as the chief reason for the latest hikes in interest rates to 8%. But make no mistake, an impact is being felt.
Food and non-alcoholic drinks account for 10.3% of the official Consumer Price Index (CPI) basket of goods and services that is used by the Bank of England’s Monetary Policy Committee (MPC) for interest rate-setting purposes. In the 12 months to the end of June, the prices of this component rose 4.8%, exactly double the overall inflation rate.
More worrying for real world shoppers, food prices have an even stronger upward influence on the headline Retail Price Index. This index, which does not remove mortgage costs from its calculation, shows inflation to be consistently higher than the CPI, and is the index most commonly used in wage bargaining negotiations. On this measure, inflation is running at 4.4%. Food and catering items account for 15.2% of the total basket of goods and services whose prices are measured. In the year to May, bread was up by 8.1%, fish 10.5%, eggs 12.3%, fresh milk 9.5% and potatoes by 12.2%.
Adding to this inflation pressure is the price of oil, which most had expected to fall this year. Instead, it is up 30% on a year ago to around $78 a barrel, a new 11-month high.
For the official CPI measure to fall back to target, in a climate of raging food price inflation, the MPC will have to up the cost of borrowing to bring down the rate of price rises in other goods and services to less than 2%. With little sign of a moderation in food prices in sight, the UK’s shoppers look set to be hit twice over – first by higher food prices and then interest rates higher than they would otherwise have needed to be.
