While many focus on “core inflation,” which excludes food and energy, inflation outside the core is becoming a concern. But the markets and the Fed exclude food and energy due to their volatile nature in the very short run. However, should inflation become entrenched in one or both of these components, it can feed into core inflation. These are the so-called secondary effects that the Fed wants to preclude.

But what has been going on with food and energy inflation? Starting with energy, we remember the huge run-up during the summer of 2006 but then oil prices eased late in the year. However, over the last couple of months much of the decline in oil prices has reversed and we are seeing a rebound in energy inflation. Energy inflation is not only no longer negative but is again a strong upward force on overall inflation with the year-on-year rate back in the 4-1/2 percent vicinity as of March and headed higher.

Oil prices have rebounded sharply the last few months. Spot prices for West Texas intermediate had fallen to almost $50 per barrel in November from roughly $77 per barrel during this past July. Now spot prices have been steadily rising to a little over $65 per barrel. Natural gas prices have firmed recently while electricity rates have been under less upward pressure. 

What about food price inflation?

Food inflation does not get the “press” that energy inflation gets. Yet, food price inflation has accelerated in recent months due both to the higher production costs from higher oil prices and due to shortages of fruits and vegetables caused by severe early spring weather in California and in the South. Higher oil prices push up the cost of running machinery such as tractors, harvesters, and delivery trucks.

Food price inflation has accelerated from just over a 2 percent pace in late 2006 to over a 3 percent pace early in 2007. And there are signs that food price inflation is getting worse.

Curiously, the high price of gasoline has driven up the price of ethanol which is a partial substitute for gasoline, and the higher price of ethanol has pushed up the price of corn. And higher corn prices mean higher production costs for food such as chicken, beef, pork, eggs, and cereal.

Due in part to the higher costs of grains, CPI inflation for cereals & bakery products and for meat, poultry, fish, & eggs has been on a sharp uptrend since mid-2006. Inflation for cereals & bakery products has risen from a pace of about 1-1/2 percent in 2005 to 4 percent currently. Inflation for meat, poultry, fish & eggs has risen from zero in spring of 2006 to about 4 percent currently.

What price pressure is in the production pipeline for some of these foods?

At the crude level of production in the producer price series, we see prices rising substantially for a number of meat products that are heavily dependent on corn as part of the production process as feed. Inflation for slaughter hogs and broilers & fryers is up sharply – around a 20 percent year-on-year rate. Cattle is not yet up as much but is still at a 10 percent pace.

Farm prices have been getting more market attention recently – and with good reason. Prices received by farmers have risen over 20 percent overall during the past year. The gains have been led by crop price but livestock is not lagging too much.  

Bottom line

With energy prices pushing up costs on the farm, we may be seeing higher food prices settling in and this must be a concern for the Fed – even if the food and energy increases are outside of the core inflation rate for now. Count on the Fourth of July picnic or barbeque costing more this year and count on the Fed to take its time cutting interest rates.