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Will food prices fuel inflation?

by LLB Editor
23rd Sep 21 11:57 am

It is not just shoppers, parents and carers who will be looking nervously at the price of food, amid shortages of truckers, container ships and carbon dioxide – investors and central bankers will be, too,” says AJ Bell Investment Director Russ Mould.

“The United Nations’ FAO Food Price Index therefore requires attention. The benchmark, which spans key agricultural materials such as cereals, vegetable oils, meat, dairy products and sugar, is up 33% year-on-year. That is the fastest rate since 2011.

“Investors will be interested – even concerned – to ascertain whether food prices will be the source of a sustained bout of inflation and one which may do damage to consumers’ ability and desire to spend.

“Central bankers will be watching, in case inflation forces their hand and requires a tightening of monetary policy in the form of a tapering of Quantitative Easing and higher interest rates.

“No doubt central bankers, to defend their view that the current spike in inflation is ‘transitory,’ will be keen to point out some of the factors involved in the food price surge. These could range from include global shipping and port bottlenecks, to a shortage of truck drivers to bad weather in countries such as Brazil, where drought and then unseasonal frost is badly affecting supply of oranges and coffee to the global market.

“But even the comparison against two years ago, before the pandemic struck in 2020, shows a 36% increase, so the current surge may not just be the result of a (low) base effect, even allowing for the role of these one-off factors.

“In many cases, the best cure for high prices of a product is high prices, as they either choke off demand or encourage additional supply. The latter may happen in time, if the weather helps, but it is not easy for people to stop eating, as they need their daily calorific intake. (In this context investors may need to keep an eye on the political situation too. Food shortages and soaring prices helped to spark the Arab Spring protests and uprisings in 2011, the Chinese Tiananmen Square protests in 1989 and before that the Russian and French Revolutions of 1917 and 1789).

“There appears to be some grounds for arguing that food prices are fuelling the current spike in inflation on both sides of the Atlantic even if the UK CPIH inflation basket has a weighting of just 8.9% toward food and soft drinks (with a further 10.4% weighting toward alcohol, tobacco and restaurants and hotels), and the US equivalent weighting is 7.6% (with a further 6.2% from eating out and 1.6% from alcohol and tobacco).

“These weightings reduce food’s overall influence and that helps to explain why the UK headline rate of inflation is 3.2% and America’s 5.4%, along with how grocers and suppliers decide to handle cost increases, either by passing them or taking the margin hit themselves.

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