Grain Prices & Food Inflation

Global grain prices have hit new all-time highs this year. Jack Summers looks at the ramifications of increased food prices on the economy.

Despite cooling off in recent weeks, spot prices are still in excess of previous all-time highs. At the time of writing, wheat sits at £308 per ton (t) rapeseed £635/t, and barley £258/t excluding premiums offered for quality specifications such as milling and malting. Wheat is currently 35% above its previous all-time high of £228/t observed in 2012 having risen 37.5% year to date.

Whilst these prices are being stoked by concerns over severe drought conditions, export bans and inventory shortages in the breadbasket regions of North and South America, India and to an extent mainland Europe,  the major force at play in global grain markets is the ongoing Russian invasion of Ukraine.

Russia and Ukraine are two of the world’s largest grain exporters, typically accounting for c.18% and c.13% of global wheat exports respectively. Several countries are heavily reliant on Ukrainian wheat, most notably Lebanon, c. 81% and Qatar, c.62%, whilst almost 100% of UK sunflower oil is made from Ukrainian sunflower seed.

The war presents both immediate and future threats to global food security. Russia’s naval superiority in the Black Sea, and reported destruction of grain storage and port infrastructure along the Ukrainian coast make exporting the estimated 30 million metric tonnes (mmt) of 2021 harvested Ukrainian grain near impossible. For context, EU proposals to export this volume by river barge or train would require c.6,600 barges and c.5,250 trains before the coming harvest to free up storage space for any new crop. Even if the Black Sea opened with undamaged port infrastructure and was cleared of sea mines tomorrow, more than 400 cargo ships would be required to bring export volume towards normal levels. In reality, experts predict it would take at least three months to make Ukrainian ports safe for merchant vessels.

Looking ahead, Russian occupation of swathes of the farmland-rich Donbas region, in addition to the disruption to input supply chains and labour availability are severely dampening the prospects of Ukrainian crops in 2022 and beyond. Analysts estimate that Ukrainian grain export volumes could fall by 19-34mmt in 2022 and 10-43mmt in 2023 depending on how the war unfolds. Whilst these ranges are broad, the figures account for the annual calorific intake of 60 million people at the lower end and a startling 100 million people at the top end. Even if the Ukrainians defy the seemingly impossible and harvest a crop in 2022, we believe export capacity is unlikely to have reverted to normal. Plus, essential storage facilities remain full of unsold 2021 crop, thereby increasing the likelihood of a spoiled crop.

Furthermore, a severe lack of cash flow and continued input supply chain disruption could force Ukrainian farmers to reduce acreages being planted this autumn, suggesting tight global grain supply is almost certain to persist into 2023.

Grain prices underpin the cost of so many foods. Collecting a basket of goods from the supermarket that is not directly or indirectly linked to grain prices is near impossible; bread, beer, baked goods, pasta, rice and oil are the most obvious examples, whilst meat, dairy, crisps and eggs are less obvious. However, the estimated 9mmt shortfall in grain supply in 2022 is not the only driver of food inflation at present. Inorganic fertiliser prices have more than doubled YoY as a result of higher natural gas prices and sanctions imposed on the key global fertiliser exporters Russia and Belarus. Higher energy and fuel prices are also increasing the production cost of greenhouse grown crops such as tomatoes and cucumbers and cold stored root crops such as potatoes and onions.

UK food inflation rose to 8.5% in May 2022, making it one of the largest contributors to the current headline CPI inflation rate of 9.1%. The nature of commodities hedging and the relative health of companies coming into 2022 has seen European food manufacturers attempt to shelter consumers by passing just half of the 16% average increase in production costs through to shelf prices. Whilst it is unclear for how long consumer staples manufacturers will be prepared to stomach large proportions of input cost inflation – eventually we suspect consumers will have to take on more of the cost increases.

Big name retailers and restaurant chains are forecasting food inflation to rise significantly higher than it is at present, namely Marks & Spencer expects 8-10% and The Restaurant Group (owner of Wagamama and Frankie and Benny’s) expects 9-10% food inflation in 2022. Similarly Capital Economics are forecasting food inflation to exceed 10% in September as recent agricultural commodity prices filter through to shelf prices.

With food inflation currently being observed across the board there is very little potential for consumers to substitute to cheaper alternatives. This situation will hit the lowest 20% of UK earners hardest. Typically this quintile spend the largest proportion (c.15%) of their £14,550 disposable income on food and non-alcoholic beverages (source: ONS), with a strong skew towards high inflation staple goods such as; bread, pasta, cereals, and crisps. Severely restricted income and little opportunity to reduce discretionary spending compared to other consumers will more than likely see real food consumption fall in this quintile.

Similarly to the ongoing energy price crisis, current food inflation revolves almost entirely around systemic supply-side issues. This presents a key challenge for central banks as rate rises are unlikely to curb inelastic demand given most groceries are non-discretionary staples. Food inflation could prove to be a very sticky component of CPI inflation in the short term if supply tightness continues.

Morgan Stanley’s Chief Global Economist, Seth Carpenter predicts that food inflation will likely contribute +0.6% to headline CPI inflation in developed markets and +1.2% in emerging markets over the remainder of 2022. These figures may appear small at face value, but could well contribute to steeper and/or more aggressive interest rate hikes in the future, so the ramifications, economically, are significant.

Jack Summers, Research Assistant

All views are those of the author and not necessarily those of JM Finn.

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