26 April 2023 Economics & Growth | Monetary Policy & Inflation | UK

When Will UK Food Price Inflation Fall?

Summary

In May 2022, we summarised an International Monetary Fund (IMF) working paper that forecasted the impacts of supply-chain issues on inflation.
Their analysis provided a good foundation for estimating the impact of rising global food prices.
By running a Vector Autoregression (VAR) on 34 countries over 26 years, we showed that the 18% rise in the IMF’s world food price index in Q1 2022 could add as much as 1.5pp to headline inflation.
The food component of UK headline Consumer Price Index (CPI) appears to be following the projected route closely. It suggests continued food price inflation stickiness.

Introduction

Nearly 12 months ago, Bank of England Governor Andrew Bailey warned of soaring food prices due to the Russia-Ukraine war. Since then, food’s contribution to UK headline CPI has more than doubled. In March 2023, the component added 2pp to overall inflation, its highest this century.

In May last year, we summarized a new IMF working paper that provided a framework to quantify the impacts of rising food prices on inflation. The authors use a panel of 46 countries over nearly 30 years to examine how increases in global shipping costs affect domestic inflation. We replicated this model to show the 18% rise in global food prices could add as much as 1.5pp to quarterly headline CPI.

We revisit this forecast for UK inflation to see whether food price rises will abate over the next few quarters.

Data and Methodology

The authors use a ‘local projection’ model, which is like the more familiar VAR used in time-series econometrics.

To quantify the impact of supply-chain issues on inflation, they regress monthly changes in the Baltic Dry Index (BDI) on headline CPI, controlling for global food and oil prices, output gaps, and differences across countries (country-fixed effects).

From this, you can straightforwardly calculate the impulse response functions, which give the percentage point change in inflation from a one-standard-deviation shock to the BDI.

For our analysis of food prices, we regress the quarterly changes in the IMF’s world food price index on headline inflation, controlling for the same variables above. Our sample is four years smaller – running from 1996-2022 – and contains 36 countries.

Food Price Shocks on Inflation

Our results show that a one-standard-deviation shock, equivalent to roughly a 7% QoQ rise in the IMF’s World Food Price index, leads to a 0.6pp increase in YoY inflation within six months (Chart 1, orange line).

For context, the end period of the index rose 18% between Q4 2021 and Q1 2022, meaning global food price rises so far could add as much as 1.5pp to headline inflation by Q3 2022. These impacts remain present for up to 18 months after the initial shock (only significant for the first six quarters) and are higher for emerging market (EM) countries (Chart 1, black line).

Will Food Prices Fall in the UK?

The forecasts have been remarkably accurate for the UK (Chart 2). Food’s contribution, in excess of its average range from 2004-2020, has followed our May forecast for advanced economies closely. In Q1 2023, food added 1.7pp more than average to headline CPI.

The results imply a sticky path ahead for UK food price inflation. Taking only the lower bound of the forecast, food will continue to add 1.2pp to overall CPI by Q2 2024. In other words, history suggests global food price shocks, such as that of early last year, have long-lived implications – especially for small open economy countries such as the UK.

A More Optimistic Outlook

Any forecast of more than two years is highly uncertain. Our results in Chart 1 were only statistically significantly different from zero for the first 18 months after the initial shock. That leaves a plausible Q2 2023 estimate, but a far less accurate prediction thereafter.

Perhaps we can infer more from developments in the US, where the food price shock appears to have filtered through more quickly. Food contributions to overall inflation peaked earlier (and at a lower level) than in the UK (Q3 2022). Since then, food price inflation has continually declined. Extrapolating forward, contributions should halve from their peak after a further 18 months.

If that trajectory holds true for the UK, food prices will add less than 0.9pp above its normal range to headline inflation by the end of 2024. With food being the largest increasing component to UK CPI, this forecasted decline should come as welcome relief.

The EU hopes for the same sharp decline. One of the most open trading areas in the world, the EU has been subjected to several global shocks. Food prices are adding as much as a third to the Harmonised Indices of Consumer Prices (HICP), well beyond its forecasted amount (Chart 4).

Bottom Line

Food prices have risen worldwide, as was expected. The hope is that the rises abate quickly to allow headline CPI to normalise, especially in the EU. However, history tells us that global food shocks have long-lasting impacts on domestic food prices. This suggests food price inflation will continue into the near future.