Europe’s Drought Risks Inflation Deluge

Categories: Calamities/Pestilence,Economy/Labor

By ANDREW PEAPLE

It will take more than a washed-out holiday weekend to put a smile back on the faces of European farmers—and policy makers. Dry weather in the continent’s northern regions has seriously harmed potential crops, with the U.K. the latest country to declare drought conditions in some parts of the country. England and Wales have experienced the second-driest spring since 1910, with rainfall 45% below the long-term average. The feed-through to inflation is getting harder to ignore.

Wheat, which accounts for nearly half of Europe’s cereal production, is particularly at risk. Already, the price of milling wheat traded in Paris has risen 6.6% this year. France, Europe’s largest wheat producer, is suffering its driest weather in 50 years, and could see its crop decline by 12% this year, the U.S. Department of Agriculture estimates. Much of the price rise will be felt domestically, with Europe consuming around 85% of its annual wheat production.

Rapeseed, another important crop used in both biofuels and edible oils, has seen its price rise by 46% from a year ago. Unless imports from Ukraine increase, the front-month futures price of about €466.50 per ton could rise to €500 per ton, Rabobank forecasts.

Such price rises are feeding through to overall European inflation: euro-zone food prices rose by 1.8% on-year in April, according to Eurostat, up from 0.1% in April 2010. Sure, the weighting of food in the euro-zone consumer-price index, at 14%, is low compared with emerging-market CPI baskets. But its weight as a source of inflationary pressure is rising. In 2010, food contributed just 4% of overall euro-zone inflation. In 2011, that could rise to 14%, according to Barclays Capital, and heading to 17% in 2012. Since food demand doesn’t fall much even as prices rise, higher food expenses will hit already stretched household budgets, especially for poorer families.

The effect of higher basic food prices is already pushing up the cost of processed food. The year-to-year inflation rate for bread and cereals has risen sevenfold in the last six months, to 2.1%, for example. But the full effect still may not have been seen: Bread prices typically lag wheat futures by around six months, BarCap estimates.

Europe’s sun seekers may be enjoying the warm conditions. But for central bankers trying control the continent’s inflation, it is another headache.

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