Tuesday, April 12, 2011 5:22 PM, Vetiva Research
NIGERIA |MONTHLY ECONOMIC NOTE
Global Oil and Food Prices; Drivers and Dependencies
· Oil and Food prices are likely to remain important drivers of headline inflation in 2011 as we have seen in most Emerging and Frontier markets. Developed economies on the other hand, are yet to feel the full impact of this price uptrend as aggregate demand remains within band. Nonetheless, pre-emptive steps are being taken through monetary tightening to manage the gradually rising inflationary expectations and sustain credibility. For instance, the European Central Bank (ECB), despite the fragile growth in the peripheral economies recently raised rates by 25bps to 1.25%. (First hike since July, 2008).
· Crude oil prices have moved sharply on the Middle East and North Africa tensions with fears of supply shortages sending prices to a 32 – month high of $126/bbl. We however believe the concerns around the trajectory of Libyan oil production though appropriate appear overdone and, current oil prices at these levels do not reflect fundamentals. We believe as these speculative assumptions are brought home, energy prices could soon become vulnerable to correction around $100/bbl as the speculative positions gradually unwind.
· Supply – side shortages with increasing demand continue to exert upward pressure on Food prices. Severe weather patterns over the past year have impacted supplies of key Food commodities such as Wheat, Rice and Corn amongst others. Though the role of speculation cannot be discounted, in this case, we believe demand and supply fundamentals underpin high Food prices going forward.
· Little attention is paid to the links between Food and Oil in economies. While point input-output estimates are not available, we extrapolate that the Food sector uses about 7% - 15% of all the energy in most industrialized economies- from the beginning to the end of the Food value chain (irrigation, transportation, storage and cooking). Higher Oil prices are likely to drive Food prices higher by increasing input and production costs which will eventually be passed on to the final consumer, with huge implications for inflation. As such, we expect an aggressive monetary tightening through 2011 - especially amongst emerging economies, with developed economies adopting a more modest policy response.