8. Future for food prices
8.1 Long-term scenarios
What direction food prices will take going forward is subject to uncertainty. This would be influenced by a number of factors, the most significant being the energy prices, agricultural commodity prices, weather conditions and economic and political conditions around the world.
Chatham House project on Food Security 49 considers four possible scenarios with regards to what the food price situation could develop into in medium term. The paper discusses four possible scenarios, each leading to different levels and trends in food prices, as a result of assumptions made about the factors that are likely to influence them.
Just a Blip
The hike in food prices turns out to be a temporary phenomenon. In this scenario prices return to their long-term trends, however, a number of factors would have to be favourable for this to be the case, including a rise in food production through increased investment, weather conditions favourable to harvests, energy prices returning to their trend levels and biofuel production falling in response. All of the above factors result in overproduction of food, and falling food prices, further exacerbated by a shift in financial speculation.
Food Inflation
This is driven by increasing demand for food derived from rising world population. The response to that is increased investment in newer technologies in food production. Oil prices settle at current level, however input commodity prices are rising and the demand constantly marginally outstrips the supply. Food inflation triggers wage pressures in developing countries, where expenditure on food constitutes a high proportion of spending. In the case for food exporting countries, this translates into higher food prices for the rest of the world.
Into a New Era
This is a peak oil scenario where oil prices are sustained at high levels and adverse weather conditions brought on by climate change result in food production hitting its fundamental long-term constraints - "peak food" is reached. Environmental pressures result in carbon and water pricing being widely accepted across the globe and a move towards a more sustainable food production and consumption is made. With new eco-technologies making a more efficient use of inputs, there is a major restructuring of the way food industry works lifting previous environmental and production constraints. This results in increased production and falling prices.
Food in Crisis
Crop and animal disease outbreaks together with water shortages trigger disruptions in food supply. On the energy side, there geopolitical pressures push the oil price up to record levels of above $200 per barrel. These factors exacerbated by financial speculation trigger significant rises in food prices, which rocket as commodity stocks are run down, partly caused by extreme weather conditions. Farming is disrupted as food is taken off the world market through price controls and export bans. Food shortage result in famines with poorest countries hit worst and ideas of consumer choice abandoned in the developed world.
Global economic circumstances would suggest that the scenario of 'Just a Blip' is already occurring, even though Chatham House project participants at the time thought this an unlikely event. However, many still see this as 'fragile peace' that can be broken at any time by supply and demand imbalances. Paradoxically, it is the higher prices that could fuel the investment required to develop more sustainable behaviour. 50
8.2 Near-term outlook
It is difficult to predict what will happen to food prices in the forthcoming months as well as in long-term. Whilst the pressures of increasing production costs from rising commodity price have eased off and the harvest forecasts are looking more promising, UK food prices are still increasing, albeit at a slower rate.
Overall, the rate of inflation is falling rapidly, as the UK economy is on the verge of deflation with RPI at 0.0% and CPI at 3.2% in February 2009. However, these have mainly been driven by the fall in oil prices transmitting into reductions in petrol and other fuel costs. The fall in RPI is also caused by lower mortgage payments that followed the continuous interest rates cuts. With the general rate of inflation on a downward trend, the gap between the food and all items inflation is still widening.
Temporary deflation can be good for consumers, as it makes goods and services cheaper and if the prices are expected to rise, this can boost demand. However, sustained deflation can be dangerous, as consumers postpone their purchases in expectation of further price falls. The economy can enter a downward spiral of sustained deflation, especially as unemployment is currently increasing.
The extent of deflation will depend on: future trends in world prices; the path of sterling and its pass-through to retail prices; the pace of loosening in the labour market; and companies' pricing decisions in an environment of weak demand. 51
The movement of oil prices will play an important role in determining inflation. Around 40% of the global oil supply is controlled by an oil cartel Opec. If production cuts are introduced by Opec, this could push up the oil price by limiting the supply of oil if cuts are sufficient to counteract the effect of global recession.
The weakening of the pound could limit retail price falls over the coming months. This however depends on the importers reaction to the depreciation of sterling currency. According to the survey conducted by the Bank of England, around 66% of companies claim they would change their prices in response to a depreciation of pound sterling of below 10%. Around 90% of importers would adjust their prices accordingly in response to depreciation of below 20%. 52 Over the last 12 months to end of March 2009, sterling has fallen 14% against the Euro and 28% against the dollar. Over the month of March 2009, pound depreciated against the Euro by 4% and given that a large proportion of food sold in Scotland is imported from the euro area, increases in food prices should be expected.
In the near future, food prices are likely to be affected by decreasing costs and falling demand. The former is the result of falling agricultural commodity prices due to better harvests and replenishment of stocks and falling energy prices. The latter is a consequence of falling consumer confidence as the UK's output contracts and recession fears increase. In the face of these trends, a decline in food prices should be expected. However, the movement of prices is difficult to predict, as it is unclear how exactly firms will respond to changes in input costs and contraction in demand and what the timing of the response will be. So far, the food price inflation has remained on the upward trend, possibly due to the importance of food as a consumption good which means that the demand for it cannot contract in line with the rest of the economy. The lag in response to lower production costs, and weak sterling are likely to have a role to play.