Six reasons not to panic about US grain prices

London, 13 July 2012

Fears of the “worst drought in the US in 25 years” have led to a spike in US grain prices and understandably added to concerns about another global food inflation shock. However, there are at least six reasons why these concerns are overdone. To recap,  this week the US Department of Agriculture (USDA) published its monthly “World Agriculture Supply and Demand Estimates”. These have generated plenty of headlines. In particular, the USDA cut its projection for the US autumn corn harvest to 12.9 billion bushels, from 14.8 billion bushels last month, citing the impact of “persistent and extreme” dryness and heat in key US producing states over the past six weeks. The forecast for the soybean harvest has been trimmed from 3.20 billion to 3.05 billion bushels, and for wheat from 2.23 billion to 2.22 billion bushels.

However, according to Capital Economics, note first that the downward revisions to US crop forecasts were no worse than expected and, for soybeans and wheat at least, pretty marginal. The grains component of the most closely watched commodity index, the S&P GSCI, comprises wheat, corn and soybeans, whose prices have already risen sharply this year. In the wake of yesterday’s report, only wheat rose any further, while the prices of corn and soybeans actually dipped.

"Second, these US crop forecasts are only forecasts. There is still a little time for weather conditions to improve and prices to fall back. Third, while the US is the world’s largest corn exporter and a key supplier of soybeans and wheat, it is by no means the only player. There is also some scope for better harvests elsewhere, notably in Latin America and Eastern Europe, to offset any shortfall in the US," according to Julian Jessop, Chief Global Economist, Capital Economics.

"Fourth, when thinking about the impact on inflation, it is important to step back a bit and look at a longer run of data. As Chart 1 shows, soybean prices have surged past their 2011 highs, but corn is only slightly above its previous peak and wheat prices are still lower.

"And fifth, and related to the previous point, the year-on-year increases in grains prices are much smaller than they were in 2007-08 or 2010-11. Even if grains prices settle at their current higher levels, rather than fall back as we expect, the lags in the pass-through to the consumer mean that average food price inflation in the advanced economies of the OECD should still decline in the coming months.

What’s more, if food price inflation does pick up again, it may simply return to current levels (Chart 2).

"Finally, of course, US grains prices are not the whole story. The price of rice, a far more important foodstuff for many developing countries especially in Asia, has been little changed. The prices of many other foodstuffs, such as sugar and coffee, have actually declined. And the prices of commodities in general, notably oil, have been weak and are likely to fall further.

"The upshot is that we remain sanguine about the inflationary impact of higher grains prices. We will revisit our price forecasts for wheat, corn and soybeans shortly, but still expect sizeable falls as supply concerns fade and the poor macroeconomic and financial backdrop dominates again."

Ends --