Sticky food inflation shows signs of easing

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Written by Citadel Global Director, Bianca Botes.

Around the world, inflation is putting consumers under significant strain, and while core inflation has started to ease, food inflation has proven to be stickier. Recent data, however, is indicating that stubborn food inflation is finally showing signs of abating, despite additional risks weighing on global food security.

Key themes for this week include:

  • Food inflation eases, but risks abound
  • Hawkish Federal Open Market Committee (FOMC) minutes cause jitters
  • Chinese economic woes persist
  • Gold nears four-month lows

NO SUCH THING AS CHEAP CHIPS

We are all familiar with the phrase “cheap as chips”, originating from the United Kingdom (UK), where the fried potato snack is not only common but also cheap. However, recently food inflation has ensured that not even chips are all that affordable anymore as global potato prices have gained a staggering 56.67% year-on-year.

A recent study by ActionAid also found that the cost of fertiliser in Bangladesh rose by a staggering 105% within a year and has resulted in a 60% rise in sugar prices. The ActionAid report aims to highlight the effect price surges are having on vulnerable and marginalised communities, but food inflation is being witnessed across the globe, and is impacting all consumers.

While food price volatility is common, the rise in food prices over the last two years has been unprecedented, and food inflation has proved to be rather sticky, even after core inflation started to cool. The cause of food inflation is multi-faceted and has resulted for a number of reasons, ranging from the supply constraints caused by the Russian-Ukraine war to an increase in global demand.

Food inflation carries significant implications, with one of the major consequences being the threat it poses to a country’s food security. As prices rise, the distribution of food among the population becomes more unequal. Food inflation also has a ripple effect on economies by causing cost-push inflation, which means that as food prices increase, the prices of other goods and services follow suit.

Short-term food inflation is primarily driven by cost-push factors, such as limited crop yields or inefficient supply chain management. These factors are often unpredictable and challenging to control. In the long term, however, food inflation is mainly influenced by demand-pull factors. As the demand for food grows, particularly due to population growth and changing dietary patterns, more land is utilized for intensive agricultural practices. This increased reliance on intensive farming methods leads to higher usage of chemical fertilizers and pesticides, placing additional strain on the environment.

Many countries also face their own set of idiosyncratic drivers of food inflation. In South Africa as an example, South African food producers, who are among the largest on the African continent, have been forced to invest substantially to address the challenges posed by prolonged loadshedding, water supply problems, and deteriorating infrastructure. This spend will ultimately result in an increase in food prices.

Despite the current high food inflation, a glimmer of hope can be seen. The UK’s food inflation for May, dipped for the first time since the start of the Russia-Ukraine war in February 2022, with food and non-alcoholic beverage prices dipping to an 18.4% rise, year-on-year, from 19.1% in April. In South Africa, while food prices remain worryingly high, and is expected to remain volatile in the coming months, the annual inflation rate for food and non-alcoholic beverages dropped sharply from 13.9% in April to 11.8% in May, close to the inflation levels last observed in September 2022.

While this offers some hope that food prices may start coming down in the short term, global risks to food security remain abound. Factors including growing populations, the ongoing Russian-Ukraine conflict, worsening geopolitical trade relations and changing weather patterns are all posing a threat to food price stability and, ultimately, food security on a global scale.

DATA IN A NUTSHELL

According to the minutes from June’s FOMC meeting, nearly all FOMC participants agreed to keep the federal funds rate unchanged. They believe that maintaining the current rate would allow them more time to evaluate the progress of the economy in terms of achieving maximum employment and price stability without triggering a sharp economic contraction. However, a few officials expressed their preference for a 25-basis-point increase in rates. Despite the differing opinions on the exact timing of rate changes, all officials shared the view that a restrictive stance for monetary policy was appropriate. This is due to US inflation remaining above the 2% target and the labour market remaining tight. This data reinforced expectations of a 25-basis-point rate hike by the Fed in July. Most participants also believed it would be suitable to raise borrowing costs again later in the year. The US Federal Reserve (Fed) maintained the target range for the Federal funds rate at 5% to 5.25% in June. Adding to the discussion, the US’s ADP National Employment Report revealed that job creation in the US economy exceeded expectations for June, while other reports indicated that job cuts have decreased to an eight-month low and continuing jobless claims have fallen to a four-month low. Investors will continue to monitor the monthly US payroll report for further insights into the monetary policy outlook.

The S&P Global/CIPS UK Composite PMI (Purchasing Managers’ Index) for June was confirmed at 52.8, down from 54 in May. This indicated a slower rate of expansion in private sector output since March. The service sector showed solid growth, but manufacturing production continued to decline. In terms of new orders, there was only marginal growth in the private sector during June. However, employment levels increased, while backlogs of work saw the most significant decline so far this year. On the pricing front, input cost inflation was at its lowest level since February 2021, while prices charged increased at their slowest pace in 26 months.

Meanwhile, producer prices in the euro area experienced a year-on-year decline of 1.5% in May. This marked the first month of price decline since December 2020. The decrease was primarily driven by a significant 13.3% slump in energy costs and a 1.5% drop in the cost of intermediate goods. Furthermore, inflation rates for capital goods, durable goods, and non-durable consumer goods also slowed compared to the previous month. When excluding energy prices, the year-on-year producer price inflation decelerated to 3.4% in May, down from 5.1% in April. On a monthly basis, producer prices fell by 1.9%, extending the trend of five consecutive months of decreases.

In June 2023, the Caixin China General Composite PMI declined to 52.5, down from 55.6 in May. This marked the sixth consecutive month of growth in private sector activity, albeit at a slower pace compared to January. While the manufacturing sector experienced growth for the second month in a row, the service sector expanded at its slowest pace in six months. New orders saw the smallest increase in five months, particularly with a notable slowdown in sales growth for service providers. Additionally, export sales recorded their slowest growth in three months. Employment levels showed growth overall, driven by job creation in the service sector, while manufacturing payrolls continued to decline. Input costs fell for the first time in over three years, primarily driven by a decrease in manufacturing costs. Output charges also fell for the third consecutive month. Dr Wang Zhe, an economist at Caixin Insight Group, highlighted the need for stronger policy support and increased efficiency to directly benefit market players, support employment, and bolster market expectations.

The S&P Global South Africa PMI for June registered a reading of 48.7, indicating the fourth consecutive month of contraction. However, there was a slight improvement compared to the previous month’s figure of 49.6. The decline in client demand continued to contribute to a decrease in new business intakes, although the rate of contraction was moderate and slightly weaker than the previous month. Expansion was observed in the construction, services, wholesale & retail sectors. However, new orders from foreign markets declined further due to weak global economic conditions.

FOMC MINUTES DAMPEN EQUITIES

US stock futures declined on Thursday, with the Dow Jones contracts falling by over 200 points, while the S&P 500 and Nasdaq 100 contracts dropped by around 0.6%. Investors are considering the Fed’s need for further tightening measures. In addition, US Treasury Secretary, Janet Yellen’s visit to China coincided with Beijing’s decision to restrict exports of metals used in chip-making to the US. In terms of individual companies, petroleum and chemical giant, Exxon Mobil’s shares dropped by over 1% in premarket trading due to a forecasted $4 billion reduction in second-quarter earnings, attributed to lower natural gas prices and refining margins. On a positive note, tech company, Meta Platforms’ shares gained nearly 2% following the launch of Threads, and Microsoft’s shares increased by 0.8% after Morgan Stanley raised the tech company’s stock price target.

The UK’s FTSE 100 index declined by approximately 0.7% to reach the 7,385 level on Thursday, marking a fourth consecutive session of losses and reaching levels not seen since mid-March. London shares followed a general risk-off sentiment, driven by concerns that further monetary tightening could have a significant impact on major economies. In the UK, traders have fully priced in an expected terminal rate of 6.5% by March 2024, which is 150 basis points higher than the current rate of 5%. On the corporate front, tech retailer, Currys’ shares fell by 12% after reporting a decline in profits. Additionally, financial services providers, HSBC and Prudential, with exposure to China, experienced nearly 2% drops as US-China tensions continue to linger.

European stock markets experienced declines on Thursday, with the DAX in Frankfurt dropping by 0.7%. Investor sentiment was dampened by increased global economic uncertainties and concerns about ongoing monetary tightening by major central banks. In terms of economic data, German manufactured goods saw a significant surge in new orders, rising by 6.4% in May, surpassing market expectations and marking the largest increase since June 2020.

Japan’s Nikkei 225 Index fell by 1.7% to close at 32,773, while the broader TOPIX Index tumbled 1.26% to 2,277. Both benchmarks experienced a third consecutive session of decline as investors opted to take profits on technology stocks that had seen significant gains. Japanese shares followed the losses on Wall Street after the release of the FOMC minutes. Technology sector losses were led by companies such as Advantest, SoftBank Group, Tokyo Electron, Renesas Electronics, Keyence down, and Abalance Corp which lost a massive 6.82%. Other major companies on the index also lost ground, including Mitsubishi UFJ, Fast Retailing, Nintendo, Daiichi Sankyo, and Mitsui & Co.

On Thursday, the local JSE FTSE All Share index dropped by over 1%, trading around 74,900, extending its losses for the third consecutive day as the Fed reaffirmed its hawkish stance. Traders also kept an eye on tensions between the United States and China. Locally, Cosatu and its affiliated unions launched a nationwide strike to protest high levels of unemployment, high interest rates, load shedding, water shortages, and inequality. On the corporate front, heavyweight tech stocks and sectors linked to resources were among the worst performers.

COPPER EYES POTENTIAL CHINESE STIMULUS

On Thursday, West Texas Intermediate Crude futures remained close to $72.00/barrel after surging nearly 3% in the previous session. The strong performance was supported by supply cuts implemented by major oil producers and a significant decrease in US crude stockpiles. Saudi Arabia announced an extension of its one million barrels per day production cut through August, while Russia declared a 500,000 barrels per day reduction in exports. Saudi Energy Minister, Prince Abdulaziz bin Salman, emphasised that these joint output cuts have proven skeptics wrong and that the expanded Organization of the Petroleum Exporting Countries, OPEC+, is committed to taking any necessary measures to support the oil market. In the US, industry data indicated a decline of 4.382 million barrels in crude inventories, marking the third consecutive weekly draw down and almost double the drop of 2.408 million barrels from the previous week.

Gold prices dipped towards the $1,900/ounce level on Thursday, reaching their lowest point in almost four months. This decline was driven by evidence of a tight labour market, which bolstered the case for a more hawkish US Fed. As the likelihood of interest rate hikes increased, the opportunity cost of holding precious metals rose.

Copper futures experienced a rebound, surpassing $3.70/pound, driven by disappointing Chinese economic data that raised expectations for economic stimulus measures in the world’s second largest economy. Furthermore, declining inventories indicated a tighter market for copper. The latest PMI survey showed a slower expansion in China’s manufacturing sector in June, primarily due to sluggish output and new order growth rates, declining employment, and weakening business sentiment. Additionally, combined copper stockpiles across various exchanges and warehouses, including the London Metals Exchange, the Shanghai Futures Exchange, the Commodity Exchange, and the China bonded warehouses, have significantly decreased by 55% since March, falling to a cumulative total of 225,018 metric tons. This level of stockpiles represents only three days of global copper consumption in 2022. In the coming months, copper prices are expected to remain volatile, influenced by fluctuations in the value of the US dollar and investor sentiment towards China’s manufacturing and construction sectors.

hIGHER INTEREST RATES DOMINATE

On Thursday, the US Dollar Index hovered around the 103.3 level, following slight gains earlier in the week. Traders are assessing the implications of potential interest rate hikes and analysing mixed economic data. The FOMC minutes, released yesterday, further reinforced expectations for a US interest rate increase this month. Currently, traders are assigning a nearly 93% probability of a 25-basis-point hike in July’s federal funds rate. The likelihood of another quarter-point increase in September has risen to 30%, up from the previous 20%. Meanwhile, labour market data, including job cuts, the ADP report, and claims report, continue to indicate a strong job market. The upcoming payrolls report, scheduled for today, will be closely watched for further insights. However, production indicators such as the ISM manufacturing PMI and factory orders have been disappointing, contrasting with the positive labour market data.

The euro remained around the $1.09 level as investors weighed the possibility of an extended period of higher interest rates against data pointing to a slowdown in economic growth and easing inflationary pressures in the euro area. The latest PMI report indicated that the eurozone economy stagnated in June, primarily due to a significant decline in manufacturing and a moderation in services activity growth. Additionally, headline inflation dropped to 5.5%, its lowest level since January 2022, while producer prices contracted by 1.5% in May, marking the first month of decline in over two years. However, core indicators remained consistently above the ECB’s target of 2%. German policymaker, Joachim Nagel, reiterated the need for further interest rate hikes, while his Italian counterpart, Ignazio Visco, suggested that the ECB could achieve its inflation target by maintaining rates for a specific duration rather than continuing to raise them.

The British pound remained stable, hovering around the $1.27 level, which is close to its 14-month high of $1.2848 reached on June 16. Investors were cautiously assessing the potential impact of higher borrowing costs, along with concerns about the Bank of England’s aggressive policy tightening leading to a possible recession. Governor of the Exchequer, Andrew Bailey, highlighted that the recent surge in interest rates reflected the strength of the economy and the unexpected persistence of inflation. Investors are now predicting that the main interest rate could rise to 6.5% by March 2024, following June’s 50-basis-point rate hike.

The South African rand traded around R18.90/$, testing a break above the R19.00/$ mark on Thursday, which was achieved in overnight trade. This was attributed to the strength of the US dollar and concerns surrounding the domestic outlook due to ongoing power supply challenges. The South African Reserve Bank’s (SARB’s) models indicated that the energy crisis may have had a significant negative impact on GDP growth in 2023, and its effects are expected to persist until early 2024. However, a further decline of the currency was limited by expectations of monetary policy tightening by the SARB in July. SARB Governor, Lesetja Kganyago, mentioned in an interview that efforts to control rising prices were yielding positive results, but emphasised the importance of a sustained decline in inflation until it reaches the desired target range of between 3% and 6%.