Morgan Stanley had a note out yesterday on the pass-through of commodity price inflation into consumer price inflation. Their conclusion is that the pass-through will be weak. But, at the margin this will keep the U.S. from tipping into deflation. Here’s a few lines from the piece by Richard Berner.
Soaring commodity food prices will lift inflation… Commodity food prices are soaring and will soon start to push up food costs for consumers: For example, prices for feedgrains like corn, wheat and soybeans are up anywhere from 20-65% (not annualized) over the past six months, while prices for imported foods like coffee and sugar have jumped by 60% over the same period. Those increases are only beginning to show up in the popular price gauges. Indeed, through September, producer prices at the crude and intermediate processing stages rose by 6.9% and 3.8%, respectively, and finished producer food quotes actually declined by 1.4%. That will soon change, of course, as those price hikes work their way through the processing pipeline.
…but only modestly. But the translation from these commodity food price hikes to those at the retail level will be much smaller – adding perhaps 2-3% to food inflation. Given the low starting point, food inflation will likely run at a bit more than 2-3% in 2011. As discussed below, several factors mute the translation and pass-through. While the expected rise in food inflation is a big change from the 1-1.5% we expect this year, the direct impact on overall inflation will only amount to 0.2-0.3%, reflecting the small share of food in consumer budgets (7.8% for food and beverages at home, and about 13% including restaurant meals). It’s worth noting that those shares have declined radically from the stagflationary 1970s, when they were 15.3% and 21.3%, respectively.
Broader spillovers? Nonetheless, the broader questions are first, whether the rise in both food and energy quotes will spill over into inflation generally by pushing up inflation expectations, wages and other prices; and second, whether such price hikes will tax consumer budgets.
The short answer to question one: Yes, but only to a limited extent. Food and energy quotes are not indicative of prices generally. They certainly influence inflation expectations, but despite their recent increase, inflation expectations by any metric are not surging; they are relatively well-anchored.
Berner sees four forces at play, pushing up food prices: strong global demand, weather, energy costs, low food stock inventories. You can read the full note at the link below.
My take is a bit different. The rise in food and energy prices should be taken into consideration by government officials conducting pro-inflationary policies. What should be of concern regarding commodity price inflation is how it represents a regressive tax on lower income workers and consumers in emerging markets and developing countries. Lower income consumers spend a much greater percentage of income on food and energy. So when commodity prices increase, it has a disproportionate effect on them. One reason we saw food riots in emerging markets in 2008 has much to do with this.
Berner notes that this inflation takes a while to pass through the system. That was certainly the case in 2007-2008 during the last rise in commodity prices when prices peaked in the summer of 2008.
The question is not whether the commodity price inflation we have seen to date will pass through. It is more whether commodity price inflation will continue or will accelerate. My expectation, like Berner is that the increase in food costs will accelerate, adding 2-3% to inflation and taking us into the 3-5% range instead of the present 1.4%. But, will it go higher than that? Will fuel prices continue higher? And what will be the impact on emerging market consumers of this price rise? In the context of the so-called currency wars, these are the right questions to be asking.
Source: Food Inflation: Less than Meets the Eye – Richard Berner, Morgan Stanley