Food for thought

 Croesus/An Investor's Guide:The markets got off to another bad start this week as Asian and European exchanges followed Wall Street's weak Friday close.

Renewed concern over rising inflationary pressures raised the spectre of stagflation - a combination of weak economic growth and rising inflation. Persistent upward pressure on global food prices has already fed through to higher consumer prices across the globe.

In the commodity markets benchmark prices for cereals have risen underlining the inevitability of ongoing inflationary pressures in 2008.

In Chicago wheat and rice prices for delivery in March 2008 have jumped to an all-time high, while soybean prices are at a 34-year high and corn prices are at an 11-year peak.

Food price inflation has been a key factor, driving inflation this year to levels above central banks' comfort zones.

In November, inflation in the euro zone rose to 3.1 per cent, well above the ECB's target rate of just under 2 per cent. The fastest rate of increase in food prices since the early Eighties explains a significant part of this acceleration in overall inflation rates in the euro zone and elsewhere.

The prospects for 2008 are for more of the same. Growing incomes in the developing world is creating extra demand for dairy and meat products, while the expanding biofuel industry has created a whole new layer of demand.

With supply constrained due to poor harvests in several categories and stockpiles low, another wave of food price inflation is now virtually assured for 2008.

Inflationary pressures are likely to limit the scope for central banks to reduce interest rates in an effort to stave off recessionary dangers.

In the 2001-2002 period, the Fed felt able to reduce the Fed funds rate to as low as 1 per cent and the ECB cut its repo rate to 2 per cent. At the time, inflation was low and inflationary pressures in labour and commodity markets were largely absent. The contrast with the current environment is stark as price pressures simmer uncomfortably across many labour and commodity markets.

A really disquieting aspect is the growing realisation that the central banks' powers to control economic developments may be far less than previously thought.

By the 1990s, inflation had been squeezed out of the system and central banks seemed to have developed the ability to smooth the economic cycle through judicious use of interest rate policy. The absence of above target inflation was clearly crucial in this regard.

The macroeconomic environment for 2008 is shaping up to be one where central banks are going to have to try both to stem inflationary pressures and at the same time limit recession risks.

Unfortunately, the credit crunch is making an already difficult task even more challenging. Last week's announcement of co-ordinated policies by five leading central banks to alleviate the global credit crunch was followed this week by action.

On Monday, the European Central Bank announced that it would offer unlimited funds at its two-week auction.

In the event, the ECB announced on Tuesday that banks took €348.6 billion at a rate of 4.21 per cent. Subsequently, two-week lending rates, which go through the all important December 31st year end, dropped to 4.5 per cent from 4.9 per cent.

In the UK, the Bank of England held its first auction of £10 billion of three-month funds on Tuesday. It allotted the full amount at an average rate of 5.95 per cent compared with the UK base rate of 5.5 per cent.

Central banks seem to be running to stand still, and it is now generally accepted that it will be at least another three to six months before credit conditions ease.

Firefighting in order to preserve the global financial system is likely to be the core activity of central banks over the next six months, with fine tuning interest rate policy to manage the macroeconomy coming a poor second.

Another week in the Irish equity market and another profits warning. Following Irish Life & Permanent's warning last week, the focus switched to the construction sector as Kingspan issued a profits warning at its scheduled trading update on Tuesday.

The story for 2007 is in line with expectations of operating profit growth of 22 per cent. For 2008, growth is expected to be much slower than prior forecasts of 10 per cent-plus profits growth.

Kingspan is now guiding profits growth of about 5 per cent to €250 million, which compares with the earlier consensus of €270 million. Conditions in many of its insulation and panels markets remain good, although momentum is slowing.

The Irish business, however, is being affected by the slowdown in the Irish housing market.

The reaction in the market was swift and harsh with the share price falling by 20 per cent on the day. On the revised profit forecasts, this puts the shares on a price-earnings ratio of 9.3, which would seem to price in even sharper profits deterioration.