Drought-driven food costs may damp consumer sentiment

The worst U.S. drought in at least 50 years may restrain consumer confidence and spending as it pushes Americans’ grocery bills higher later this year.

Food prices will increase an average 4% annual rate in the nine months ending June 2013, up from 1.5% currently, said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York.

That may trim real disposable incomes by 0.3 percentage point from the fourth quarter of 2012 through the first half of next year and reduce spending by a similar amount, he estimates.

The projected food-price increase will squeeze budgets of households already contending with a 13% gain in gasoline prices since early July and unemployment that is stuck above 8% three years into the economic recovery. Consumer sentiment has yet to return to pre-recession levels, confidence gauges show.

“Energy is hitting us now, food is going to hit us later,” Feroli said. “It will be a headwind for consumers. It’s going to damp people’s perceptions of the economy.”

While the effect on total inflation will be limited and transitory, food and fuel costs have a disproportionate impact on confidence because consumers make frequent stops at grocery stores and filling stations. Food and fuel together account for about 24% of the consumer-price index, according to the Labor Department.

“Even though it may not have a big impact on headline inflation, it can affect inflationary expectations,” Feroli said.

FOOD FACTORS
The U.S. Department of Agriculture has declared almost 1,600 counties in 32 states as natural-disaster areas after the drought seared millions of acres of pasture and cropland. South Dakota, Nebraska, Missouri and Illinois are among states facing the greatest crop-yield losses, according to the department.

It will take time for agricultural commodity increases to show up on grocery store shelves because food companies buy raw materials months in advance. Price gains are limited because the farmers receive only a small portion of the retail prices, with the rest going to processing and distribution.

The nation’s corn harvest will be the smallest in six years, according to the U.S. Department of Agriculture. Corn and soybean futures each jumped to a record on the Chicago Board of Trade this month.

Dean Foods Co., the largest U.S. dairy processor, is among companies watching farm products to assess where costs may be headed.

“While we are keeping an eye on rising corn and feed prices, we think the upward impact on dairy prices could be less extreme than some analysts predict,” Gregg Engles, CEO of the Dallas-based company, said Aug. 8. Commodity prices are “going to provide some headwind to us rather than a tailwind.”

PRICE INCREASES
Feroli estimates rising food costs may add 0.3 percentage point to 0.4 point to the year-over-year rate of inflation in the period from October 2012 to June 2013. Energy, a more immediate threat, may add 0.7 point to CPI in the third quarter of this year. Consumer prices rose 1.4% in July from a year earlier, the smallest increase since November 2010.

The impact on inflation will subside in the second half of next year unless there is another drought. “I wouldn’t expect food inflation to persist,” Feroli said.
Some economists say concerns about the fallout from the drought are overblown.

“Rising food prices are obviously something to keep an eye on, but they’re not likely to change the outlook on inflation or on growth,” said Kevin Cummins, an economist at UBS Securities LLC in Stamford, Conn. “The direct impact from higher food prices will be marginal.”

Cummins projects food prices will rise 2.75% this year and 3.5% next year. The gains will boost CPI growth by 0.1 percentage point in 2013. That amounts to an extra $35 for groceries in 2013, or an additional $3 a month, for the average household, he said.

Beef prices may even drop in the short term as record feed costs prompt ranchers to reduce the size of herds, increasing the supply of meat, according to JPMorgan and RBS Securities. Prices may rise again as beef becomes scarce, with the USDA estimating output will slump to a nine-year low in 2013.

Even before food prices begin their ascent, reports on the drought are affecting consumer moods, said said Omair Sharif, a U.S. economist at RBS Securities Inc. in Stamford, Conn.

“Consumers are seeing the scary headlines in the news,” he said. “It enters your psyche right away, and you become more cautious.”

ENERGY, CONSUMER REPORTS
The average price of a gallon of gasoline at the pump rose to $3.75 on Aug. 26, up 42 cents since July 1, according to AAA, the nation’s largest motoring organization.

Gasoline climbed to the highest in almost four months, while oil fell on speculation Tropical Storm Isaac will have limited effect on production in the Gulf of Mexico. Gasoline futures rose 2.3% to $3.15 a gallon in late Monday (Aug. 27) morning trading in New York, and oil dropped 1.1%.

In the U.S., a report tomorrow (Aug. 28) from the Conference Board may show consumer confidence was little changed in August. July’s reading of 65.9 compares with 87.8 in November 2007, before the start of the 18-month recession.

The Thomson Reuters/University of Michigan preliminary August consumer-sentiment gauge increased to 73.6, the highest level since May, from 72.3 the prior month.

The Bloomberg Consumer Comfort Index fell for the sixth straight week in the period ended Aug. 19 as Americans held more pessimistic views on their finances.

“Consumers don’t have a lot of cushion,” said Sharif.

Unemployment and weak job growth have left little prospect for higher wages, which will likely “stagnate,” he said.