More Evidence of Food Price Inflation

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This Financial Times story, “Growing biofuels demand raises food prices,” highlights increasing prices of grains and other soft commodities. The grain price rise merits particular attention, since it appears to be a structural rather than a cyclical increase. And higher grain prices in turn mean higher meat, milk, and egg prices.

What this story does not mention is that the combination of higher food prices on top of energy price increases may finally create the impetus for corresponding wage increases. That would represent the beginning of a wage-price spiral, every central banker’s nightmare.

From the FT:

Soft commodities are hardening. Corn, wheat, cocoa and coffee prices have all risen strongly in recent months, suggesting consumers will face an extended period of more expensive food.

This year, corn and wheat prices have reached their highest levels for a more than a decade, while coffee prices have hit an eight-year high and cocoa has risen to a four-year high.

Yet while price gains for cocoa and coffee have been driven by adverse weather affecting production during a period of rising consumption, analysts say grains prices are experiencing a structural shift, owing mainly to the growing demand for biofuels.

“Just as energy and metals prices have rallied sharply in real terms, a similar fate awaits grains, which remain significantly below the [inflation adjusted] highs of the 1970s and mid-1990s,” says Michael Hughes of Deutsche Bank.

Recent price strength has sparked fears that consumers could face higher bills, while policymakers are concerned that rising food prices will drive inflation higher. In addition, global food demand is rising strongly, thanks to economic growth.

Predictions for higher prices come in spite of expectations that global grain production will rise 6.2 per cent to a record 1.666bn tonnes in 2007-08, according to the International Grains Council. However, this will not match global consumption – forecast by the IGC at 1.680bn tonnes, up 3.1 per cent on the previous year.

The situation for cocoa and coffee is different from grains. Coffee’s strength has been driven by adverse weather affecting production in Vietnam and Brazil, the two largest producers.

Biofuels are gradually taking over as the main growth driver of agriculture demand. Goldman Sachs says that if government policies are adopted in full, global demand for biofuels could increase from 10bn gallons a year to 25bn gallons by 2010.

Goldman expects the trend rate of growth in demand for agricultural commodities to rise from 1.9 per cent a year between 1997 and 2006 to 2.6 per cent a year between 1996 and 2015.

This is expected to lead to an extended period of high prices. Goldman forecasts that five years from now, corn will trade at $5 a bushel, compared with about $3.50 on Monday, while wheat will rise from $4.50 to $6 a bushel.

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