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El Niño Could Cause Supply Shocks and Inflation in 2023

Foreign media said that just when investors thought they could safely expect interest rates to peak soon, more bad news was coming.
According to the US National Oceanic and Atmospheric Administration and the Australian Bureau of Meteorology, El Niño appears to have made a comeback. Its presence often causes or exacerbates floods, heat waves, water shortages and wildfires, especially in the southern hemisphere. That would damage crops and infrastructure and create inflation, putting pressure on the central bank to tighten monetary policy. If climate change makes such events more intense and more frequent, supply shocks will be inevitable.

This year’s El Niño could break records . The phenomenon occurs when surface temperatures in the eastern and central Pacific Ocean are at least 0.5 degrees Celsius above average, weakening or reversing the flow of the trade winds. The strongest so far was in 2016, when sea surface temperatures were 2.6 degrees above average. The Australian Meteorological Service revealed a few weeks ago that the gap could reach 3.2C this November.

So far, traders have focused on some of the commodities most likely to be affected . In June of this year, rice futures reached their peak in the past 15 years except for the epidemic. India, Thailand and Vietnam, the three largest rice exporters, have already experienced record or near-record heat this year and often drier weather due to El Niño.
In anticipation of water shortages, Thai authorities in May asked farmers to grow only one crop, rather than two. Vietnam is already in a state of drought, which has also affected the yield of Robusta coffee trees. Last week, the robusta coffee futures contract reached its highest price since it was launched in 2008 and is up 60% this year.

Some argue that a single El Niño appears to be manageable . According to calculations by the International Monetary Fund in 2015, the phenomenon could push up oil prices by nearly 14 percent and nonfuel commodity prices by more than 5 percent within a year of its occurrence.

But the IMF analysts concluded that the largest increases in headline inflation over the past 12 months were only around 1%, and that was limited to a handful of the most exposed countries, including Brazil, Indonesia and Mexico. Researchers at Dartmouth University extended the time frame this year and estimated that the second strongest El Niño on record – the 1998 El Niño brought $5.7 trillion (in 2017 dollars) to the global economy over five years count) losses.

Things have changed a lot since then.

First, the world is warming . The eight years since the IMF paper was published have also been the eight hottest years on record for the world, despite cooler temperatures in the Pacific Ocean since 2020, leading to the opposite of El Niño, La Niña.

On the one hand, global warming has exacerbated droughts in parts of Europe, China, Southeast Asia and the United States, and El Niño conditions may worsen in some of these regions . On the other hand, it creates the conditions for more severe floods because the air can hold 7% more water for every 1°C increase in its temperature. That means crops that normally benefit in places where El Niño brings wetter weather, such as U.S. soybeans, currently hit hard by a lack of rain, are now at greater risk of being submerged.

Oceania has felt some of the effects during La Niña. Australia’s second year of flooding drove food inflation to an annualized 9% in the three months to September 2022, the highest since 2006, according to Rabobank . A month after the cyclone hit, New Zealand’s fruit and vegetable price index rose 22 per cent year-on-year in March. Heavy rains and frost also cut coffee production in Brazil and other Latin American countries in 2021 and 2022, pushing futures prices to 10-year highs last February while spurring increased demand for robusta coffee beans.

The direct impact of El Niño and La Niña weather on planting, planting and harvesting is not the only economic consideration.
Infrastructure may also be damaged or destroyed as a result. Early last year, for example, floods washed away the only 30-kilometre rail line that transports food to Western Australia.

Separately, sugar futures may have reached some near 12-year highs in June amid concerns that excessive humidity could knock Brazil’s cane fields even worse than in 2016, according to Barclays data. But there is another reason, with last season’s disappointing harvest and the prospect of El Niño-induced water shortages prompting India, the world’s second-largest producer, to effectively ban sugar exports until next year.

There have been other recent examples of protectionism under the guise of national food security. All this uncertainty constitutes a potential supply shock that could drive up prices in the coming year alone . Warming due to climate change will make these shocks more common; the World Meteorological Organization announced in May that there is a 98% chance that the next five years will be the hottest period on record due to a combination of greenhouse gas emissions and El Niño.
Foreign media believe that after dealing with the difficulty of dealing with the inflation storm caused by the epidemic and the conflict between Russia and Ukraine, policymakers may also face a powerful new economic storm.

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