Focus

September 17, 2021 | 13:26

Will Food Feed Faster Inflation?

Economist

Senior Economist and Director
Economics

Aaron analyzes performance and risk across a diverse selection of industries and countries. His research is regu... (Read more)

Douglas Porter , CFA

Chief Economist and Managing Director
Economics

Douglas Porter has over 30 years of experience analyzing global economies and financial markets. As Chief Econom... (Read more)

Michael Gregory , CFA

Deputy Chief Economist, Head of U.S. Economics and Managing Director
Economics

Michael is part of the team responsible for forecasting and analyzing the North American economy and financial m... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Benjamin Reitzes

Director, Canadian Rates & Macro Strategist
Fixed Income Strategy

Benjamin has been with the Bank of Montreal for over a decade. He is responsible for the Canadian macro-economic... (Read more)

Jennifer Lee

Senior Economist and Managing Director
Economics

Jennifer has been with BMO Capital Markets Economics for over two decades and is perhaps best known for her high... (Read more)

Art Woo

Senior Economist and Director
Economics

Art joined the Bank of Montreal in 2014. His primary responsibility is analyzing global economic, financial and ... (Read more)

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with the Bank of Montreal since 2006. He plays a key role in analyzing regional economic, fiscal... (Read more)

Shelly Kaushik

Economist
Economics

Shelly joined BMO Economics in 2020 and conducts research on U.S. regional economies. She also provides support ... (Read more)

Priscilla Thiagamoorthy

Economist
Economics

Priscilla joined BMO Capital Markets in 2016 and plays a key role in analyzing Canadian household trends and the... (Read more)

Aaron Goertzen , CFA

Senior Economist and Director
Economics

Aaron analyzes performance and risk across a diverse selection of industries and countries. His research is regu... (Read more)

Douglas Porter , CFA

Chief Economist and Managing Director
Economics

Douglas Porter has over 30 years of experience analyzing global economies and financial markets. As Chief Econom... (Read more)

Michael Gregory , CFA

Deputy Chief Economist, Head of U.S. Economics and Managing Director
Economics

Michael is part of the team responsible for forecasting and analyzing the North American economy and financial m... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Benjamin Reitzes

Director, Canadian Rates & Macro Strategist
Fixed Income Strategy

Benjamin has been with the Bank of Montreal for over a decade. He is responsible for the Canadian macro-economic... (Read more)

Jennifer Lee

Senior Economist and Managing Director
Economics

Jennifer has been with BMO Capital Markets Economics for over two decades and is perhaps best known for her high... (Read more)

Art Woo

Senior Economist and Director
Economics

Art joined the Bank of Montreal in 2014. His primary responsibility is analyzing global economic, financial and ... (Read more)

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with the Bank of Montreal since 2006. He plays a key role in analyzing regional economic, fiscal... (Read more)

Shelly Kaushik

Economist
Economics

Shelly joined BMO Economics in 2020 and conducts research on U.S. regional economies. She also provides support ... (Read more)

Priscilla Thiagamoorthy

Economist
Economics

Priscilla joined BMO Capital Markets in 2016 and plays a key role in analyzing Canadian household trends and the... (Read more)

Feature

Will Food Feed Faster Inflation?

All eyes are understandably on inflation these days. Through the first eight months of the year, consumer prices advanced at a 4.4% annualized pace in Canada and 6.6% in the United States. Transitory or not, that is easily the hottest inflation has run since the mid-2000s, and by some measures, the early 1990s. The forces lifting prices are no mystery. Consumers are flush with cash and eager to spend, which is pulling inflation higher from the demand side, while supply chain disruptions, commodity prices, and labour shortages are pushing upward from the cost side. Vehicles, energy, and shelter are perhaps the most widely discussed hot spots, but global food prices are also on the boil. With grocery and restaurant spending weighing in at around 15% of the CPI basket, it’s worth considering whether food inflation might just be warming up.

Unlike most goods and services, food prices jumped at the beginning of the pandemic as households packed their pantries and virus outbreaks disrupted production (Chart 1). Since then, food prices have remained surprisingly buoyant, especially in the United States, even as panic buying has subsided and food processors have adapted to the pandemic. On a two-year average basis, which captures price changes over the entire pandemic, inflation on U.S. food at home accelerated to 3.8% annualized in August—a ten-year high. North of the border, food inflation has been dampened by the recovery of the Canadian dollar, leaving the two-year average at 2.1%. That number may not raise many eyebrows, but food prices have rarely grown much faster in a rising-loonie environment and the currency is expected to advance only modestly from here.

Food is becoming pricier in part due to dry growing conditions across much of North America. The U.S. Drought Monitor estimates that 58% of the continental United States is grappling with abnormally dry weather, while in Canada, 79% of agricultural land is facing the same. The drought has impeded fruit and vegetable production on the West Coast, while parching field crops on the prairies. In Canada, wheat and canola yields are expected to be more than 30% below normal this year, and farmers on the U.S. plains haven’t fared much better. Although corn and soybean production has done well by comparison, continental stockpiles of all major crops are beginning to run low, as scarcity in the wheat space has diverted demand into other products (Chart 2). As a result, key crop prices vaulted to decade-highs (give or take) earlier in the year, and remain well above recent norms.

Livestock supply has also become leaner, which is putting upward pressure on meat prices. In the cattle space, the headcount of the North American herd turned lower before the pandemic and fell further last year after meatpacker closures depressed farm-level pricing (Chart 3). This year, the herd is set for another decline, as the drought is forcing producers in hard-hit regions to cull. Overall, the North American cattle herd is on track to end the year around 2% smaller than it was at the end of 2018. The hog segment has seen similar supply dynamics, with the North American herd likely to end the year 2% smaller than its recent high at the end of 2019.

Farmers are also facing higher costs, which are cascading into grocery prices (Table 1). Energy and fertilizer costs have escalated particularly quickly. In the United States, the cost of refined petroleum products has leapt 29% over the past two years, while fertilizer prices have jumped 25%. Canadian farmers are facing similar numbers. The cost of agricultural equipment and construction has also increased sharply, and while pesticide prices have edged lower, they have done so from the artificially high levels caused by the China-U.S. trade war. Livestock farmers are also facing higher feed prices.

Robust food demand is adding fuel to the fire. On both sides of the border, real grocery spending has remained far above pre-pandemic levels even as the restaurant industry has reopened (Chart 4). In the United States, grocery volumes actually increased during the first half of 2021 and were roughly 12% above pre-pandemic levels in Q2. In Canada, grocery purchases took a step back in Q2 but remained 8% above pre-pandemic levels. Demand for agri-food exports has also risen, thanks to the end of the China-U.S. trade war, which had weighed heavily on agricultural trade. Rising ethanol production is providing an additional lift to crop demand, raising input prices for food processors.

Food inflation will eventually slow, but it will take time. For one thing, today’s higher agricultural prices have yet to be fully passed through to consumers, since food processors tend to lock in their input costs in advance. This suggests continued pressure on food prices as manufacturers roll into more costly contracts. Agricultural markets are also expected to remain tight, at least in the near term. Even with a stronger harvest next year—which is far from guaranteed—dwindling crop inventories will take time to replenish. The livestock herd will also take time to recover, especially in the cattle space, where the gestation and development cycle is long. On the demand front, a major pull-back in food spending is unlikely in the near term, with the labour market strengthening and household balance sheets in good shape. All of this suggests that above-average food inflation is likely to persist into 2022, at which point prospects for a bigger harvest could offer a reprieve—or not, depending on the weather.

Bottom Line: Rising food prices are another nuisance for central banks and the transitory inflation narrative. Industry-specific factors are clearly at play, but with overall inflation running at the fastest pace in recent memory, the upswing in food prices is harder to ignore.