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Where are food prices heading? Short-term drivers, trends and implications

The current surge in food prices is due to the superposition of short-term drivers and a structurally tight supply-demand balance. Short-term food price fluctuations have been largely related to supply-side factors. Over the long-term, rising global demand is exerting significant upward pressure (in a context of supply constraints). It is driven by strong income growth in emerging market economies – also by population growth and increased demand for biofuels.

Food price increases are likely to remain an important driver of headline inflation in emerging market economies, where consumers spend over 50% of their income on food. Pass-through from commodity prices to consumer prices is particularly low in the OECD where more processed food is consumed.

Weather-related production shortfalls, policies (e.g. export bans), oil prices and exchange rates are all factors impacting food prices in the short-term. Though the role of speculation is not clear, it is probably not as important as supply and demand fundamentals but potentially amplifies price spikes. Increased transparency and appropriate regulation of derivative markets, if necessary, should be helpful in reducing excesses.

Food prices are likely to start decreasing in the course of 2011 but remain high for the remainder of this decade. The situation is particularly tense for corn, also for soybeans. Wheat prices may subside in the next months in the absence of further weather disruptions. (The persistence of the current drought in China could have dramatic consequences). The rice situation is of no concern at the moment and rice prices should not rise substantially.
Spikes in food prices are expected to occur with increasing frequency in the future, mostly due to weather disruptions and intensified by climate change. The situation can be alleviated in the long-term by a sustainable increase in supply, especially by boosting smallholders yields in developing countries.

Concerted action is needed for emergency responses to shocks. Building food reserves is part of the solution. Better information on production, consumption and stock levels would lead to better educated market decisions and would likely stabilise markets.

It is also important to avoid restrictions in the flow of food – keeping in mind the interests of developing countries. Export restrictions usually disrupt world markets, often drive global prices up and reduce domestic incentives to increase supply.