News Column

Declining food prices increase the risk of global deflation

August 24, 2014

Arab News, Jeddah, Saudi Arabia



Aug. 24--JEDDAH -- International food prices have been declining in recent months, reflecting record harvests and weak global demand. Declining food prices have in turn contributed to lower inflation in the euro zone, the United Kingdom (UK) and the United States (US). This trend, coupled with a weak Eurozone recovery and mixed economic data in the US, suggests that the risk of global deflation remains high. As such, we expect the European Central Bank (ECB), the Bank of England and the Federal Reserve to keep to record-low interest rates for an extended period of time. Qatar's policy rates are likely to follow suit.

Since the peak in 2011, global food prices have dropped significantly, largely in response to recent bumper harvests. According to the International Monetary Fund (IMF), maize prices have fallen 41 percent since their peak in 2011. Over the same period, rice prices have fallen nearly 31 percent and wheat prices have declined 20 percent. These large declines are feeding into lower food prices for consumers around the world. While lower food prices would normally be a good thing as they lower living costs, this decline comes at a time when inflation is already very low in advanced economies and could turn inflation negative, namely deflation. This is a cause of concern as deflation increases the real value of outstanding debts in the economy which can in turn reduce the available income available for consumption and lead to lower growth.

Looking ahead, the IMF is projecting a further decline in global food prices (averaging -3.8 percent in 2014-15) on record yields. The global food production outlook continues to remain favorable, with the supply of major grains and oilseeds projected to surpass demand growth for the next two years. Furthermore, China expects increased production of corn and wheat as a result of favorable weather while global rice supplies continue to be plentiful.

For the global economy, lower food prices for the next 18 months could mean a higher risk of deflation. Food prices account for only 10 percent-15 percent of the inflation basket in advanced economies, but they can reach 30 percent-40 percent in emerging markets and developing countries. At the current juncture, euro zone inflation has fallen to its lowest level in July 2014 (0.4 percent year-on-year) since the height of the financial crisis in 2008-09, sliding further into what the European Central Bank (ECB) has described as a "danger zone". UK inflation fell to 1.6 percent year-on-year in July 2014 as a result of lower food prices. Finally, US inflation fell to a five month low of 2.0 percent year-on-year in July 2014. Overall, global inflation is very low by historical standards and heading lower.

In Qatar, whilst rising rents continue to push up domestic inflation, this has been partly offset by falling food prices. Food inflation in Qatar peaked at an annual increase of 5.9 percent in June 2011 and has since slowed to a negative 0.6 percent in June 2014. Since the country has virtually no domestic food production, lower international food prices are likely to continue to push Qatar's food prices lower for the foreseeable future, albeit with a lag. This means that Qatar's inflation should remain moderate at around 3.5 percent at least until the end of 2015.

Historically low inflation in the EU, the UK and the US is likely to mean that central banks will keep interest rates at historic lows for a prolonged period of time to avoid the risk of deflation. Deflation could potentially halt the already weak global recovery by reducing consumption -- something that central banks cannot afford. A pause in tightening monetary policy in the US would also have the added benefit of bringing greater stability to global financial markets, which have been unraveled by the tapering of quantitative easing since May 2013. Qatar's interest rates are likely to follow US policy rates, given the peg to the US dollar.

Overall, the risk of global deflation remains high as bumper harvests and a weak global recovery have pushed down inflation to record lows. This is likely to keep global interest rates low for the foreseeable future.

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(c)2014 the Arab News (Jeddah, Saudi Arabia)

Visit the Arab News (Jeddah, Saudi Arabia) at www.arabnews.com

Distributed by MCT Information Services


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Source: Arab News (Saudi Arabia)


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