Global Themes - Risks From Higher Food Prices

  • We have assessed the potential for higher global food prices in 2014, and our core view is that they should remain relatively well contained. However, though we expect grain prices to average lower in 2014 than they did in 2013, there are some significant upside risks to prices, ranging from weather factors to trade disruptions.

  • This is a key global risk, since food price spikes have played a role in some of the most significant emerging market crises of the past several years. These include the 2007-08 inflation scare, which gave rise to tighter monetary policy just as the floor fell from under the global economy, and the 2010-11 Arab Spring uprisings in the Middle East and North Africa.

  • Similar factors may come into play in emerging markets this time around, should food prices surprise to the upside. Emerging markets with high food weightings in their consumer price baskets would be particularly vulnerable.

  • Higher food prices could have a major impact on markets in H214. Monetary authorities may be forced to tighten or maintain tighter policy more than they would like (as in the case of Brazil), and the risks of civil unrest will be heightened.

Globally, disinflation and deflation are a bigger risk than inflation in 2014, with commodity prices continuing to moderate, deleveraging cycles underway in Europe and elsewhere, and mounting downside risks to emerging markets growth. One component of this global view is the likelihood of moderating food prices, as we continue to expect global grain prices to generally average lower in 2014 than 2013 as supply improves and demand growth remains relatively subdued. However, we highlight some key flashpoints that could drive food prices higher in the coming months. In particular, we see upside risks to prices from prospects for stronger ethanol production, the possible return of El Niño, improved livestock production and trade disruptions. The effect of these issues could be exacerbated by speculative sentiment, which has been rebounding and shows room for further upside. This is a key global risk, since food price spikes have played a role in some of the most significant emerging market crises of the past several years. These include the 2007-08 inflation scare, which gave rise to tighter monetary policy just as the floor fell from under the global economy, and the 2010-11 Arab Spring uprisings in the Middle East and North Africa. Here, we discuss the potential for higher prices in H214, and how this will affect key emerging market regions and countries.

Food Price Inflation: Where Are The Risks?

A Return To 2010 Unlikely
S&P GSCI Grains Index & % chg y-o-y

Global Themes - Risks From Higher Food Prices

  • We have assessed the potential for higher global food prices in 2014, and our core view is that they should remain relatively well contained. However, though we expect grain prices to average lower in 2014 than they did in 2013, there are some significant upside risks to prices, ranging from weather factors to trade disruptions.

  • This is a key global risk, since food price spikes have played a role in some of the most significant emerging market crises of the past several years. These include the 2007-08 inflation scare, which gave rise to tighter monetary policy just as the floor fell from under the global economy, and the 2010-11 Arab Spring uprisings in the Middle East and North Africa.

  • Similar factors may come into play in emerging markets this time around, should food prices surprise to the upside. Emerging markets with high food weightings in their consumer price baskets would be particularly vulnerable.

  • Higher food prices could have a major impact on markets in H214. Monetary authorities may be forced to tighten or maintain tighter policy more than they would like (as in the case of Brazil), and the risks of civil unrest will be heightened.

Globally, disinflation and deflation are a bigger risk than inflation in 2014, with commodity prices continuing to moderate, deleveraging cycles underway in Europe and elsewhere, and mounting downside risks to emerging markets growth. One component of this global view is the likelihood of moderating food prices, as we continue to expect global grain prices to generally average lower in 2014 than 2013 as supply improves and demand growth remains relatively subdued. However, we highlight some key flashpoints that could drive food prices higher in the coming months. In particular, we see upside risks to prices from prospects for stronger ethanol production, the possible return of El Niño, improved livestock production and trade disruptions. The effect of these issues could be exacerbated by speculative sentiment, which has been rebounding and shows room for further upside. This is a key global risk, since food price spikes have played a role in some of the most significant emerging market crises of the past several years. These include the 2007-08 inflation scare, which gave rise to tighter monetary policy just as the floor fell from under the global economy, and the 2010-11 Arab Spring uprisings in the Middle East and North Africa. Here, we discuss the potential for higher prices in H214, and how this will affect key emerging market regions and countries.

Food Price Inflation: Where Are The Risks?

After three major food price spikes in the preceding five years, Chicago Board of Trade (CBOT) grain prices - which include corn, wheat, soybean and rough rice - generally declined sharply over 2013, falling by an average of 25%. Only prices for rice (which is relatively lightly traded) managed to buck the trend. A key reason for the collapse in prices was a massive rebound in grain supplies during the 2013 calendar year, brought about by record high plantings (particularly in the Americas). As a result of the supply surge, all four major grains recorded a surplus in 2013/14, grain prices (particularly corn and wheat) were some the worst performers in the entire S&P GSCI commodities universe, and food prices registered the most significant level of deflation since the global financial crisis.

We still expect grain prices to average lower y-o-y in 2014. As outlined in our respective commodity price forecasts, we have long expected production growth for key grains in the 2014 calendar year to come in below 2013 levels, mainly owing to a smaller area dedicated to crops - a result of the collapse in prices. Indeed, we forecast a decline in global production growth from three of the four main crops in 2014, with only rice output growth expanding. However, global markets remain relatively well-supplied by recent historical standards, and global demand growth from the various livestock sub-sectors for feed remains subdued as high prices either prevented or delayed herd rebuilding in 2013. For example, the global beef cattle herd was lower in 2013 than in 1985 even as retail meat prices in key markets in Europe and the US reached record highs. The result of our relatively moderate grain demand growth outlook for 2014 is that even with the reduced supply prospects, all four major grain markets will remain in surplus for the 2014 calendar year, only the 11 th such occurrence in 50 seasons and the first since the 2010 calendar year, illustrating the improvement in market supply.

A Return To 2010 Unlikely
S&P GSCI Grains Index & % chg y-o-y

Nonetheless, we remain of the view that grain prices are likely to remain in deflation only until H214. Food price inflation will re-appear in H214 owing to low base effects after the S&P GSCI grains index collapsed throughout 2013. Indeed, having held technical support around 400, the index has already been trending higher in recent months, in line with a view we have had since September that grains prices would find support around that level by the end of Q413. Assuming the grains index remains at around the current spot rate, the index will return to year-on-year inflation by late July. Moreover, most of the price risks for grains lie to the upside, and include geo-political concerns, weather issues, improved grain demand and investor sentiment.

Asia - Low Risk of A Regional Spike In Inflation: Although we see potential for the recent rally in grain prices to add upside pressure on regional inflation dynamics over the coming months, we are not overly concerned for the region as a whole, given that we forecast a slight slowdown in Asian growth and expect currency strength for the broader region (except for China), which will help limit imported price pressures. Thus far, inflation readings in several of the larger economies in the region remain below central bank inflation targets, or at least the upper limit of their target band which suggests that there are no imminent risks to the regional inflation outlook. Moreover, we forecast regional growth to slow from 5.1% in 2013 to 4.8% in 2014, which should help contain demand-side inflationary pressures. Lastly, despite the slowdown in growth, we expect Asian FX to remain strong over the coming months - largely on the back the sharp selloff in 2013 - which will help to limit imported price pressures. The two outliers here are India and Indonesia, both of which display inflation readings close to the central bank's target (India) or well above it (Indonesia). However, given the aggressive tightening by both central banks since H213, which has seen an easing of inflationary pressures and the recent stabilisation of their currencies, we see potential for both central banks to lower interest rates towards the end of the year as their focus shifts from inflation towards growth concerns.

Inflation Not Yet A Concern In Asia
Asia - Regional Inflation Metrics* (LHS) & Currency Performance Year To Date (%)

Korea shows that inflation readings are well below the central bank's target, which suggests that there is room for inflation to rise before monetary authorities start to worry about inflation. In China, we believe that the slowdown in economic growth from 7.7% in 2013 to 7.1% in 2014 should keep inflationary pressures in check. That being said, we see two risks to this view. First, persistent weakness in the currency could result in imported inflation, and potential for a mini stimulus could see inflationary pressures pick up in China and within the broader region. Although Japanese inflation figures remain below the Bank of Japan's 2.0% target, we are watching inflation carefully given the massive monetary and fiscal stimulus, which has seen a rapid rise in inflation expectations.

Given our more dovish expectations with regard to regional growth and inflation, we continue to see value in some local fixed income markets. In particular, we have been bullish Indonesia's local currency 2023 bond since January, and believe that it could rally further still. We are also bullish Australia's 15-year local currency government bond, as we forecast the Reserve Bank of Australia will cut interest rates by 25 basis points to 3.25% by year end. As for Japan, given that we see rising inflation risks as well as the growing risk of a fiscal crisis, we remain bearish Japanese local debt.

Latin America - Brazil Highly Exposed To Rising Food Prices: We expect that price pressures will remain relatively well contained in most major Latin American economies this year, with Argentina and Venezuela remaining notable exceptions. However, given the relatively high weightings of food in Latin American consumer price baskets, a spike in global food prices could lead to more significant monetary tightening than we currently expect this year, as central banks attempt to bolster exchange rates and ease imported price pressures. Incidents of political unrest are likely to be limited in major economies, although we could see more significant ructions in parts of Central America and the Caribbean, as many of these smaller economies are highly dependent on food imports.

Higher Prices Would Have A Major Impact
Latin America - Weighting Of Food Prices In CPI, % (LHS) & Inflation, % chg y-o-y 3 MMA(RHS)

Although Argentina and Venezuela have some of the heaviest weightings of food in their consumer price baskets, we believe that a spike in global food prices would have a relatively limited impact, given that we already forecast average inflation of 30.0% and 50.0% respectively in 2014. Instead, we anticipate that rising food price inflation could have the greatest impact on our political and economic expectations for Brazil. Indeed, we have previously highlighted that an uptick in food price pressures would pose upside risks to our interest rate outlook this year, potentially prompting the Banco Central do Brasil to hike the Selic rate above our short-term target of 11.25%, and forestalling the 50 basis points (bps) of easing to 10.75% that we envisage in late 2014. In addition, another spike in food prices could reignite the protests that swept the country in June 2013, due in part to growing concerns over high living costs. Moreover, drought conditions in several areas exacerbate the risks of a broader increase in global food prices, and we will be watching month-on-month food price inflation closely in the coming months for signs that these risks are beginning to play out.

Emerging Europe - Food Prices No Threat To Policy Trajectory: We do not expect food price inflation to have a significant impact on monetary policy trajectory across the Emerging Europe space in 2014. Food inflation has been in a sustained disinflationary trend across the region (excluding Turkey and Russia) throughout 2013 and has been an important driver of slowing consumer price growth during this period. Coupled with subdued demand-pull inflationary pressures, weakening consumer price growth across the region prompted respective central banks to ease monetary conditions in 2013. However, with domestic demand firmly on the mend, inflationary pressure looks set to rise, implying that the easing cycle in Emerging Europe looks now to be over.

Food Price Inflation Bottoming Out
Selected Economies - Food Consumer Price Index, % chg y-o-y

While food prices are expected to rise across the region, the impact on headline inflation will vary. The Central European countries (Czech Republic, Poland, Hungary, Slovakia) and Slovenia are more insulated from food price shocks than the Balkan and the Baltic countries. In the former, food prices comprise around 20% of the consumer price basket, whereas in the latter food prices comprise 33% on average. However, even in the case of the more vulnerable economies, we do not expect food price inflation to push headline inflation high enough to prompt a reversal of the policy trajectory given the significant slack in labour markets and subdued domestic demand across the region, which will ensure limited demand-pull inflationary pressures through 2014.

Even though Turkey and Russia have been a notable exception to the trend in food inflation across Emerging Europe in 2013, we similarly believe that food price inflation will not threaten the policy trajectory in either country this year. Food price inflation in Turkey has been soaring since Q113 and has been largely driven by lira depreciation throughout 2013, which has pushed up the cost of production for farmers and distributors. Similarly in Russia, food inflation remained elevated throughout 2013, contributing to stubbornly high headline inflation. However, even if food price inflation remains elevated in Turkey and Russia this year, we would not expect this to induce a rate hike in either as the slowing domestic demand story should prevent both countries from tightening monetary conditions.

Sub-Saharan Africa - Region Relatively Insulated From Global Grain Price Rally: The recent rally in global grain prices poses little risk to inflation in Sub-Saharan Africa. Food prices in the region are - with a few exceptions - largely set by domestic weather conditions rather than global commodity markets. Although food is the largest component of the consumer price basket in all of the Sub-Saharan Africa (SSA) countries that we cover, and the trajectory of food prices and is therefore a major determinant of headline inflation, we do not believe that the recent rally in global grain prices will lead to a spike in regional price growth.

Food Prices Dominate Most Consumer Price Baskets
Africa - Food Component Weighting In Consumer Price Basket, %

In many SSA countries, staple foods are largely produced domestically by either commercial or subsistence farmers, and prices are more susceptible to domestic and regional weather conditions than global commodities market dynamics. Furthermore, many regional governments maintain national reserves of staple crops that are used to smooth out supply disruptions in local areas. There are exceptions to this dynamic, Senegal, for instance, imports large quantities of rice and is therefore more vulnerable to movements in global rice prices than many of its SSA counterparts. However, our Commodities team are forecasting that rice prices will average lower in 2014 than in 2013 and we therefore believe that the risk of an inflation spike in rice-importers is limited.

That is not to say that African markets are completely immune to global food prices. Indeed, where shortfalls in domestic and regional production arise, countries are forced to turn to global markets to cover these deficits. Higher global prices therefore can feed through to inflation in times of lean domestic harvests. Structural current account deficits in many countries mean that currencies often come under pressure at times of increased food import demand and this adds to domestic inflationary pressures. We highlight the East African economies of Uganda, Kenya and Tanzania as being particularly vulnerable. Food price inflation is already higher in these countries than in most others in the SSA region due to poor rains. The outlook for headline inflation in East Africa is not helped by the fact that the region is particularly reliant on hydroelectricity and weather-related food disruptions are often accompanied by higher energy costs and depreciatory pressure on currencies due to higher demand for oil.

Middle East And North Africa - North Africa Most At Risk From Food Price Spike: North Africa and Yemen are the most at risk of a spike in food prices, while the Gulf largely has the financial capacity to shield their populations from such an event. Upside risks to grain prices present a threat to North African countries, which rely heavily on imports to supplement domestic food production. Any shocks to international food prices would have a large and immediate impact on consumer price inflation (CPI): food products account for a third of the CPI basket in Tunisia, 40% in Egypt, and 43% in both Algeria and Morocco. In turn, this poses a risk to political stability, particularly with socioeconomic tensions already at high levels in many countries. All North African governments currently provide heavy and largely untargeted food subsidies, which would shield consumers from the brunt of any spike in prices. Yet the cost of these policies is high, and a rise in food inflation could further aggravate fiscal strains in the region.

Gulf To Be Relatively Unaffected
MENA - Food Price Contribution To CPI Basket & Latest Inflation (% chg y-o-y)

As well as North Africa, Yemen is particularly at risk to a spike in food price inflation. Wheat imports satisfy 95% of the county's domestic consumption and thus any return of food price inflation would have significant ramifications on already elevated political instability, especially as food accounts for 51.1% of the country's CPI basket. Moreover, elevated price pressures will constrain the monetary authorities' ability to encourage growth in the economy by cutting interest rates, which we forecast to remain at the current level of 15.00% at the end of 2014.

For much of the Gulf, the political and policy impact of a food price spike is minimal. As was the case in previous food price spikes, governments across the region have the capacity and willingness to cushion any impact on citizens to reduce the likelihood of popular discontent. That said, over the longer term we are forecasting a narrowing of the fiscal surplus for the Gulf countries, and thus the capacity to absorb food price shocks will be reduced.

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