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Food Inflation

Food Inflation

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Published by: teembill on Mar 18, 2011
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Special Report
TD Economics
www.td.com/economics
March 18, 2011
WEATHERING THE STORM OF FOOD PRICES
Severe weather over the pasttwo years have impacted globalsupplies of key food commodi
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ties and generated substantialupward pressure on food prices.Food inflation has been elevatedin emerging markets since lastyear, but has yet to impact ad
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vanced economies fully.For Canada, rising global foodprices take one year beforeproducers pass increased costsonto consumers. This is likelyto occur in the coming months.Canadian food inflation, as mea
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sured by the food component of the CPI, could rise to as high as7-8% on a year-over-year basisover the next 9-12 months.Fortunately, these kinds of shocks do not tend to last. Asimilar run-up in global foodprices was recorded in 2007 and2008 when severe weather wasalso to blame. However, pricesdid eventually fall back to their pre-crisis level once growingconditions improved and Ca
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nadian food inflation fell backtoward its long-term average of about 2% by 2009.We’re expecting a similar storyto play out going forward. Weare already beginning to see thisoccur as the prices of severalkey food commodities haverecently begun to fall.
Food ination has been a serious issue in a number of emerging markets sincethe middle of last year. A string of severe weather systems over the past two yearsthat have spanned the globe have wreaked havoc on crops and destroyed supplies of critical food commodities, driving up prices in the process. In response, governmentsaround the world have turned to protectionist trade policies and mass hoarding ina bid to curb domestic inationary pressures and improve food security. However,this has only put further pressure on already strained supplies and exacerbated theupward price momentum. In contrast, food price ination – as measured by the foodcomponent of CPI – has remained subdued in Canada and other advanced economiesthus far, but that story issoon likely to change asretailers begin to pass onthe cost of higher pricesfor grains and other foodcommodities to consum
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ers. From a Canadianperspective, food price in
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ation will likely peak atroughly 7-8%. However,this should prove tempo
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rary, lasting for about 8-9months. Canadians cantake some comfort in thefact that these kinds of shocks to food suppliesand prices generally ease as weather conditions normalize and global suppliesrebound, as was the case in 2007-08.
The Astronomic Rise of Food Prices
According to the food price index released by the United Nation’s Food &Agricultural Organization , average food prices have increased by more than 67%since February 2009. However, prices have been rising particularly rapidly sinceJune 2010, increasing by 40% since then. The index is now at its highest level sincethe UN began tracking prices in 1990. While demand for food is indeed growing,particularly in emerging markets, this would support only moderate price gains over long periods of time. The recent experience is much too rapid to be sustainable andis likely cyclical in nature.There are three major factors behind the food price boom. First, a series of dev
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astating weather events around the globe have either dramatically reduced yieldsor have outright destroyed crops of a number of critical food commodities sincethe beginning of 2010. The El Niño and La Niña phenomena, which were last seenin 2008, are largely credited and the effects have ranged from extreme dry condi
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tions in Russia and Argentina; and severe droughts in China, to oods in Australia,
HIGHLIGHTS
Francis Fong
Economist
416-982-8066mailto:francis.fong@td.com
 
UN FOOD PRICE INDEX
8010012014016018020022024026090 92 94 96 98 00 02 04 06 08 10
Index, January 1990 = 100Source: United Nations Food & Agricultural Organization
 
Special Report
March 18, 2011
TD Economics
www.td.com/economics
2
Pakistan, Southern Africa, Brazil, and the Canadian Prairies;and cold snaps all across North America. Global supplieshave tightened considerably, as a result.The second factor relates to the response by govern
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ments to the supply shock. Some, like Russia and India,have turned to export bans or quotas, while others haveopted to outright stockpile commodities to secure their ownsupply and, hopefully, curb inationary pressures. Neither response is prudent from a long-term perspective. Large-scale purchases and mass hoarding has simply caused supplyto contract further, while protectionism is more likely toinhibit the supply response (ie. greater agricultural output)that would typically help normalize these cyclical pricemovements.Third, speculators appear to be playing a role in drivingup prices. While fundamentals ultimately drive long-termmovements in commodity prices, a consensus is buildingthat investors chasing short-term returns can add to short-term price volatility. Low returns on xed-income invest
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ments and rising risk appetite appear to be the main driver of investor demand. In addition, investors are likely keyingoff of the structural impact on food and other commoditydemand coming from the growth in emerging economies.According to the Commodity Futures Trading Commission,there has been a considerable increase since last June in thenumber of traders purchasing futures with the expectationthat prices will increase.Fourth, an increasing share of North American agricul
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tural production is being earmarked for biofuel productionrather than consumption, particularly in commodities likecorn and oilseeds. The food versus fuel trade-off is becom
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ing increasingly relevant as additional countries implementpolicies to increase the share of renewable energy in trans
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port fuel. Agriculture and Agri-food Canada has estimatedthat annual world biofuel production could double to 220billion liters by 2020.
Food Ination is on its way to Canada
Retail food price ination has not yet emerged fullyamong advanced economies. Both in Canada and the U.S.,food ination has increased since last June, but remains inthe 1.5%-2.0% range on a year-over-year basis – far fromworrisome levels. However, food prices have been a seri
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ous issue for emerging markets for almost a full year now.In some of the most populous countries in the world, suchas Indonesia and Brazil, food ination has risen from 3-4%on a year-over-year basis in mid-2010, to between 10-15%currently.The lagged impact on Canada and the U.S. is likely dueto erce competition amongst producers and retailers inhibit
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ing their ability to pass on increased costs to consumers. InCanada, changes in global food prices typically take aboutone year before they fully pass through to nal goods prices.In addition, food ination is unlikely to reach the same levelas in emerging markets. Raw agricultural inputs representonly a small fraction of the prices paid at grocery stores.The remainder is accounted for by processing, packaging,transportation, storage, retailing, and other business inputs.It has been estimated by the Canadian Wheat Board thatraw wheat accounts for just 15 cents of the price of a loaf of bread that consumers pay
1
. On the same token, however,energy prices can then inuence food prices as the afore
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mentioned inputs are more affected by energy costs. It hasbeen estimated that about one-fth of all energy used in theU.S. is accounted for by the supply chain of food
2
. Energy
NET LONG NONCOMMERCIAL POSITIONS -AGRICULTURAL COMMODITY FUTURES
-200-10001002003004005006002005 2006 2007 2008 2009 2010 2011-80-60-40-200204060
Wheat (right)Corn (left)Soybeans (left)Source: Commodity Futures Trading CommissionContracts, thousands Contracts, thousands
FOOD INFLATION IN SELECTED COUNTRIES
-4-20246810121416182009 2010 2011
Y/Y % Change in Food CPI ComponentIndonesiaChinaBrazilCanadaU.S.Source: National Statistical Agencies
 
Special Report
March 18, 2011
TD Economics
www.td.com/economics
3
price gains have been slightly less remarkable than thoserecorded by global food prices, however.The elevated Canadian dollar likely also plays a rolethrough lowering the price of imported food. Canadiansspent more than $85 billion on food in 2010, while importsof food products amounted to more than $25 billion. Asignicant portion of those imports would have been usedin the production of processed foods, but it provides someinsight as to how much a high Loonie can have on foodprices given the substantial size of imports.So, roughly one year has now passed since global pricesbegan their ascent and, true to form, prices at the consumer level are beginning to respond in Canada. A major Canadianfood producer recently announced a 5% price hike in itsproducts, and a major grocery chain has warned that foodprices will begin to rise soon, as producers continue to facehigher input costs. Going forward, price pressures will con
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tinue to mount as the prior year’s gain in global food pricesfeed into prices paid at grocery stores.Fortunately, the impact on overall headline ination willremain moderate. In emerging markets, food ination is acritical issue as food plays a much larger role in an averagehousehold’s expenditures. In the world’s six most populouscountries (not including the U.S.), representing almost half of the world’s population, food constitutes between one-third and one-half of a household’s consumption basket. InCanada and the U.S., however, food accounts for just 17%and 15%, respectively.
How high and how long? A comparison with the 2007-08 cycle
So, food ination is on its way to Canada. The big ques
-
tions that remain are: how rapidly could food prices rise andhow long could ination remain above its 2.2% long-termaverage? This will ultimately depend on the lagged impactof the past year’s rise in global food prices and where theyhead from here. Unfortunately, this is difcult to predictgiven the uncertain nature of things like weather, growingconditions, and political developments. To that end, welook to recent history for some insight. The current foodprice cycle is uncannily similar to one that Canadians wentthrough just a few years ago. The last El Niño and La Niñacycle came in 2007 and 2008. At the time, severe weather systems had destroyed crops of critical commodities, sup
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plies of foodstuffs around the world had contracted, bothagricultural and energy prices had soared, governments hadinstituted protectionist policies, and food prices in emerg
-
ing markets were reaching critical levels. The UN’s priceindex rose by 67% over 18 months, while in Canada, foodination increased dramatically from 0.2% in February 2008to a high of 7.9% in March 2009, one full year after foodprices began rising.However, by the end of 2008, weather and growingconditions had improved and supply rebounded as farm
-
ers increased both acreage and yields, mostly through theusage of better fertilizers. As a result, global food pricesrecorded price declines in excess of one-third in less than ayear and fell back to slightly above their pre-crisis levels.In Canada, food ination fell to just 1.25% by December 2009. Thus, given the similarities in circumstances, weexpect both prices and supplies to follow a similar trend asit is most likely the case that such weather-related supplyshocks will not persist. This is not the rst El Niño and LaNiña cycle the world has gone through, nor will it be the
FOOD WEIGHTING IN CONSUMER PRICEINDEXES BY COUNTRY
17%15%33%47%51%31%40%51%0%10%20%30%40%50%60%
CanadaU.S.China est.)IndiaIndonesiaBrazilPakistanNieria
% of national CPI basketSource: National Statistical Agencies
UN FOOD PRICES INDEX &FOOD INFLATION IN CANADA
-4-2024681092 94 96 98 00 02 04 06 08 10-60-40-20020406080
Food CPI (left)UN Food Price Index (right, 12-mth lag)Y/Y % Change Y/Y % ChangeSource: UN Food & Agricultural Organization, Statistics Canada

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