Economists chew over 'agflation' and wonder if high food prices are here to stay Reuters Published: Tuesday, May 15, 2007
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 three per cent in April, just off a two-year high, driven by food-price inflation of 7.1 per cent.
U.S. food prices, normally in line with broader price levels, are expected to outpace the general inflation rate by as much as two per cent for the next two years. A leading culprit in Britain's 3.1-per-cent inflation in March, famously beyond the Bank of England's target zone, was food prices, up nearly twice as much.
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.
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.
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, director at Fathom Financial Consulting.
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.
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.
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 U.K. economist at Lehman Brothers, thinks the food factor could impinge on medium-term inflation forecasts.
