El Nino and inflation

It might seem a little perverse to consider the northern hemisphere's prospects for next winter, given that many parts of the region are currently experiencing record high temperatures. But a regularly occurring climate event - El Nino, which is now present - is likely to wreak havoc on the global economy by the end of the year and throw many forecasts on the trash heap. El Nino was so christened by Peruvian fishers who noticed centuries ago that sometimes their catches dropped around Christmas. No two El NInos have precisely the same impact on global weather patterns but in general they result in reduced agricultural production and abnormally cold winters in the northern hemisphere.

This year's El Nino looks like it's going to be severe. The Climate Prediction Center in the US has said there is an 81% chance of this El Nino having a "moderate-to-strong intensity". Two previous extreme El Ninos (1982-83 and 1997-98) had deleterious long-term effects, reducing US gross domestic product (GDP) by 3% in five years following them.

The current El NIno may knock sideways central banks' planning. Consumer price inflation (CPI) is slowing, albeit at a snail's pace. Headline inflation in the UK was 7.9% in June, down from 8.7% the previous month; the CPI in the US was 3% last month; in the 19 member states of the Eurozone inflation actually rose in June by 0.2% to 5.5%. While price rises are generally slowing in the UK, some individual items are still showing astonishing rises. Sugar, for example, was recorded in June as rising by an annualized 53.6%. Why so extreme? The International Sugar Organization (ISO) in May reduced its forecast of a global sugar surplus from a previous 4.15 million tonnes to 850,000 tonnes - but that's still a surplus.

Food and energy prices are generally excluded from the headline rate of inflation and dealt with in so-called 'core' inflation. In the UK core inflation is also dropping but from a 30 year high of 7.1% in May. It's now an annualized 6.9%. In the US the core inflation rate is almost 5% compared with a long-term average of 3.68%. In the US, the UK and the Euro region central banks are struggling to get inflation back to a targeted 2%/year. Despite interest rate hikes - the only tool they appear to have to combat inflation - inflation, and the consequent loss of purchasing power of fiat money, continue to defy them. With El Nino the risk is that inflation may have a resurgence in a few months, if global food production is reduced by droughts and a cold winter renews price volatility.