Credit Suisse Commodities and inflation

Substantial changes in commodity prices have important implications for the global economy and for global inflation. However, while we expect many commodities to appreciate significantly over 2011, in our view, it is likely that the prices of those commodities that have traditionally had the greatest impact on the global inflationary process, oil and thermal coal, will increase less than many agricultural commodities and metals.

Consequently, the overall impact on inflation is likely to be less than in 2007 and 2008, with much of the focus on food prices.
• In most industrialized economies, this suggests that the impact will be modest, particularly against the background of weak and falling core inflation and still significant output gaps.
• For emerging market economies, the impact is likely to be more significant. In large part this is because the share of food prices in emerging market consumer price baskets is larger than in developed economies. It also reflects the fact that growth in emerging markets has been stronger, with resource utilization at a high level.

Given that we expect grain prices in particular to move higher, emerging markets commodities should be very much in the spotlight. Several governments, most notably China’s, have already begun to focus policies on trying to limit food price inflation – in part in an effort to ensure that it doesn’t spill over into broader based inflation – but also in an attempt to minimize the social consequences of higher food prices.

While the objectives are understandable, it should be noted that there is a risk that policies aimed at addressing food price inflation, such as price caps and trade restrictions, will reduce the effectiveness of the price mechanism in the adjustment process. The risk is that in implementing policies that control prices in the short term, governments inadvertently reduce the incentives for higher production and lower consumption, thereby exacerbating the imbalances. For example, if major exporters were to impose further export restrictions, the reduction in supply to the global market could result in significantly higher food prices over coming years.