Prices overall have actually fallen
Food and energy prices in the global markets have jumped noticeably in recent months and fuelled talk of inflation.
The Food Price Index of the Food and Agriculture Organisation of the United Nations, which tracks the prices of 55 food commodities, climbed for the sixth consecutive month to hit a record high 214.7 points in December 2010. This is the highest level since its inception in 1990 and beat the previous record during the food crisis of June 2008. Year on year the index has risen by 25 per cent.
In particular, soaring prices for sugar, corn, grain, meat and oilseeds pushed the index to its new peak.
Sugar recently reached a 30-year high, US corn prices surged 52 per cent last year, US soybean prices rose 30 per cent and European wheat prices doubled.
Although adverse weather conditions, such as the floods in Australia, contributed to the rising cost of food, they only partly accounted for the overall price growth.
Meanwhile, price of oil rose 10.2 per cent in November and December 2010 alone, pushing the price for crude above $90 a barrel.
All these global market events are bound to hit the pocket of consumers at some stage.
Prices up in US
In the US
, McDonalds announced last week that it plans to raise prices in 2011 to deal with the rise in commodity prices.
“As commodity and other cost pressures become more pronounced as we move throughout the year, we will likely increase prices to offset some but not necessarily all of these increases,” said McDonald’s Chief Financial Officer Peter Bensen.
The average price McDonald’s pays for its core ingredients, beef, chicken, cheese and wheat, is expected to go up by 2 per cent to 2.5 per cent this year.
Yet despite these price increases, inflation has so far not taken hold.
At RBC’s 2011 market outlook from a hedge fund perspective event in Cayman on 2 February, panellists were confronted with the question why inflation had not arrived yet.
Timothy Schuler, senior vice president and investment strategist with the Permal Group, said that “inflation is here in certain aspects”. For example, it has started to show in certain commodity prices and has driven some of the problems in Tunisia and Egypt.
In the developed world, inflation is not a problem and may not become a problem, he said. As basic necessities such as food and petrol costs do not make up as large a share of the take-home pay, it is much less of an issue than in the rest of the world, Mr. Schuler said. “When 30 to 40 per cent of your take home pay goes to feed the family and the price of rice goes up by 25 per cent, you have a problem.”
In the US or Cayman the largest asset that most people own is typically their house. As “h
ousing prices continue to be under pressure, we are not seeing that inflation feed through”, said Mr. Schuler.
Consumer prices in Cayman
Like elsewhere in the world, Cayman’s consumer price index shows signs of inflation in some areas and deflation in others. Cayman’s overall inflation rate therefore does not tell the whole story.
Since the basket of consumer products and prices was changed in June 2008, prices overall have actually fallen. After the third quarter 2010, the latest available data, the consumer price index was 1.3 per cent lower than 27 months earlier.
This overall deflation was mainly due to declines in electricity and gas prices from their highs in 2008 and the general drop in housing costs. Actual rents are 21.2 per cent lower than they were in June 2008 and imputed rents were down 12.1 per cent.
During the 27 month period gas prices had initially increased by 16.4 per cent in the third quarter of 2008 before falling to 28.2 per cent below the June 2008 level in June 2009. Since then energy prices have climbed steadily and are now just 4.1 per cent off the prices in the second quarter of 2008.
Health and transport prices
Health and transport prices also experienced a drop during the 27 month period with health costs standing at 2.2 per cent below the June 2008 level and transport costs marginally higher after an increase in the third quarter of 2010.
These price drops are contrasted by an increase in the prices for food, alcohol, tobacco, communication, education or restaurant meals.
Since the CPI product basket was altered in June 2008, food prices have increased by 9 per cent, with fruit (28.3 per cent), vegetables (16.6 per cent) and meat (11.9 per cent) as the highest price drivers.
Strongly influenced by duties and taxes, alcohol and tobacco prices jumped 8.5 and a massive 61.5 per cent respectively.
, this drove up the prices of restaurant meals and catering services by 15.2 per cent.
Clothing prices returned to 2008 levels from minor increases but the cost of footwear grew by 11.1 per cent during the time period.
As housing and utilities account for approximately 40 per cent of the product basket, significant price declines managed to cushion price growth in other areas, in particular food, alcohol and tobacco.
As a result, supermarkets were able to pass on much of the price increases from the commodities markets.
Now that the crude oil price has briefly jumped above the $100 mark, it is likely that both electricity and gas prices are going to increase again.
In the local housing market, however, the supply and demand situation has shifted significantly with more than 5,000 work permit holders having left the island since December 2008. It is therefore not clear whether rental prices have found a bottom already or if there is room for a further price decline.
Given that there is typically a delay before the new supply and demand situation has been priced in and due to lower rents generally being locked in for some time, rent increases should be some time away.
Wage growth, another important factor for inflation to take hold, is also currently missing, said Mr. Schuler. Given the high unemployment rates, wage growth also remains unlikely for the immediate future.
Dave Dobell, managing partner at Saguenay Capital, said that headline numbers, such as the oil price and other commodity prices, will continue to print high in 2011.
To demonstrate how this will affect the profitability of businesses, Mr. Schuler gave the example of Whirpool’s recently announced 60 per cent decline in operating margins.
“That is enormous,” he said, and the result of increasing input costs. Whirlpool will have to cut costs and become more streamlined, but raising prices will be difficult, he said.
“If they raise their prices, guess what, LG and Samsung are going to eat their lunch. So they are not going to raise their prices.”