'Agflation' haunts the market

With food inflation in South Africa running at over 10%, a new danger is haunting the marketplace – a creature called "agflation", or agricultural price inflation.

Investment managers Merrill Lynch published a research report on Tuesday, which highlights that 'agflation' is still with us, has become more prevalent globally, with the nasty consequence of pushing up headline inflation globally. They add that it is accelerating in developing economies like South Africa and will continue to be a factor longer term, even though slower growth short term may cause prices to ease a tad.

“We continue to believe that 'agflation' will remain a force on the inflationary front for the coming years," they point out.

This phenomenon is changing overall inflation expectations. SA's consumer inflation rate excluding mortgage interest has been outside its 6% target band for a full nine months, and the worst is not over. It has placed huge pressure on the policy makers to raise rates – but even raising rates is not doing enough to stop food from pushing the overall rate. Other consumer-related areas like installment sales may have slowed, but the food price remains a serious threat despite these hikes. The central bank was forced last week to increase its overall projections for the peak in inflation to a whopping 8.5% for the first quarter of the year.

Merrill Lynch notes that 'agflation' has in part been driven by price pressures due to the introduction of energy into the food equation.

They add that there may be some cyclical downside risk to food prices in 2008 if growth becomes weak enough.

"Price gains could slow in 2008 while price levels could remain high. Longer term, however, we remain convinced that ‘agflation' will be an important issue for consumers and policy makers alike," explain the analysts.

As to the secular ‘agflation' theme, they note that it remains intact.

"Global constraints on food production are shifting production patterns and pressuring prices. Economic development, pollution, and a lack of water for irrigation are all forces behind the constraints on arable land," they explain.

"The population in the developing world is aging, and dietary patterns are changing accordingly. The emerging markets are going through a period of economic development and urbanisation where per capita incomes are rising. As a result, food consumption is transitioning from a simple subsistence diet to more processed foods," they add.

"Energy's introduction into the global agricultural production function has put tremendous upward pressure on food prices. Given the continued development of the emerging economies, energy demand should remain strong and alternative energy should continue to put pressure on food production," say the Merrill Lynch analysts.

The analysts note that China's inflation rate may be heading to a 10-year high due in large part to ‘agflation'.

‘Agflation' in Singapore, meanwhile, is rising more rapidly than at any time in almost the last 30 years.

While some pullback in food inflation will be a welcome relief, albeit if only due to the higher base set a year ago, the fact that prices will remain high on the whole remains a concern, as it impinges on consumers' ability to spend elsewhere to grow the economy and to save more.

South Africa's food price index increased by 10.4% in 2007 after a 7.2% increase in 2006 and only a 2.2% increase in 2005. It was up 13.5% year-on-year in December. CPI excluding food was up 7.7% y/y in December, whereas overall CPI was up 9%.

This inflation also hits the poor hardest, with their consumer inflation rate up 11% in December from 8.8% for wealthy people.

Article via I-Net-Bridge