Food inflation is hard to digest for central banks

LONDON, March 31 (Reuters Breakingviews) - When inflation rises, energy often delivers the initial hit. But food prices leave the sour aftertaste. This poses a major problem for central banks pondering how to react to the closure of the Strait of Hormuz. Even if they curb spending by hiking rates, beleaguered families will struggle to cut down on eating.

So far, investors and policymakers’ main concern about the Middle East conflict has been the ​disruption to oil and gas flows. Yet the risk to the global agriculture supply chain is equally large. Major Gulf countries supply a third of the world’s exports of urea — a key fertiliser ingredient. Grocery inflation also ‌often follows energy inflation: transportation accounts for 20% to 40% of final food prices, according to Bank of America, and gas is a key input for fertiliser production. Prices of rice, cotton, palm oil and sugar, among other commodities, have already risen.

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Granted food-input prices do not imply maximum pain right now. As of last week, the S&P GSCI Agriculture Index, which tracks eight agricultural commodities, was still down about 1% from a year earlier, despite the S&P GSCI Energy Index having risen roughly 40% over the same period. This decoupling between short-term energy prices and agricultural prices reflects expectations of a short lived ​Gulf conflict. Unlike Russia’s 2022 invasion of Ukraine, which suddenly removed a chunk of world food trade, fertiliser shortages emerge gradually via reduced crop yields over multiple planting seasons. Nevertheless, historical patterns suggest that the rise in oil and ​gas prices we’ve already seen should be enough to push agricultural commodities up 12%.

That may not seem dramatic. Researchers have found, opens new tab that just 10% to 20% of global food price increases are passed ⁠onto final buyers. Patterns from 2022 and 2023 similarly place that number at 15%, OECD data suggests. So 12% agricultural commodity inflation would amount to supermarket prices rising by about 1.8%. One reason for the seemingly modest pass-through is that trends in domestic agriculture ​often outweigh, opens new tab whatever happens in international markets. Another is that food inflation has steadily declined in rich countries over the past five decades.

This is consistent with “Engel’s Law,” named after 19th century statistician Ernst Engel: as people become wealthier, they spend a smaller share of income ​on eating and drinking, which is why food has gone from comprising a quarter of consumer baskets in the United States in the 1970s to 16% now. Also, processed foods have reduced the raw materials embedded in final products. In developed economies, oil and gas are typically far more volatile than food. They also pass through to consumer prices twice as much and do so faster.

Yet what matters most to central banks isn’t headline inflation, which will mechanically jump alongside commodity prices. The key metric instead is “core inflation,” obtained by stripping out volatile items. It’s intended to show whether prices are ​likely to spiral upwards. A supply crunch in basic inputs raises costs across industries. This generates second round effects, as workers seek higher wages to offset lost purchasing power and firms raise prices to preserve margins.

In a speech in Frankfurt last week, European Central ​Bank President Christine Lagarde said she will particularly focus on how long these effects last. She also noted that some are “non-linear,” meaning they intensify at high inflation levels.

Food plays a major role on both counts. It remains twice as large an outlay for the average household as ‌energy, and is ⁠also the most frequent purchase. That means it has a disproportionate weight, opens new tab on perceptions of how prices are increasing today - and how much they’ll rise in the future. Ratesetters view the latter factor, known as inflation expectations, as a key driver of entrenched pay demands. The post-2022 experience showed that, at a time of supply disruptions, food inflation can suddenly return with a vengeance: roughly four months after energy price rises had already peaked, food created a second inflationary hump. This was a headache for the Bank of England as late as 2025.

The same could happen again. A Breakingviews regression analysis of OECD data from 1971 to 2025 suggests that, if the food and beverage component of the consumer price index rose as much as the energy component, it would have 10 times the impact on ​core inflation. A one off 1.8% monthly increase in food prices ​would initially lift core inflation by just 7 basis ⁠points, whereas an 11% energy shock would raise it by 11 basis points.

But food effects would carry more inertia, adding 50 basis points to inflation a year later versus 43 basis points for energy, and taking six extra months to dissipate. Taken together, these two hypothetical but plausible shocks would lift core inflation from 3.6% to a 4.5% peak, according to Breakingviews calculations. If world energy prices ​rise further in a prolonged disruption, the inflationary effects would be steeper still.

Core inflation would remain below the post pandemic peak of 7.7%, which makes sense: three years ago, advanced economies ​had lower unemployment and vast pent ⁠up savings, allowing people to keep spending and negotiate stronger wage contracts. Officials at the ECB, the BoE and the Federal Reserve know this, as well as the fact that higher rates wouldn’t address the source of the inflation — scarcer commodities.

As Lagarde acknowledged, however, ratesetters will still move to squeeze the economy if inflation strays even farther from the 2% target. Yet Engel’s Law also works in reverse: households can cut back on eating out and switch to cheaper brands, but demand for nourishment can only fall so much. By increasing borrowing costs for ⁠producers of primary ​goods, officials can actually make matters worse, opens new tab.

This is especially true in emerging markets, where supermarket shelves are more tightly linked to raw input prices and food accounts, opens new tab for ​20% to 60% of consumption baskets. Breakingviews calculations suggest those economies’ core inflation would peak 120 basis points above current levels, given the same 40% and 12% increase to energy and agricultural commodities, respectively.

Energy already poses a difficult puzzle for central banks. Add a food crunch, and the probability of them reaching the right ​solution plummets.

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Editing by Liam Proud; Production by Shrabani Chakraborty

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Jon Sindreu

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Jon Sindreu is the London-based global economics editor for Breakingviews. He was previously a reporter and a columnist for the Wall Street Journal, where he covered macroeconomics, financial markets and aviation for 11 years. He holds a master’s degree in financial journalism from City St George’s, University of London. He also holds degrees in computer science and journalism from Universitat Autònoma de Barcelona, in his natal Catalonia.

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