“Agricultural and Energy Prices Sound Alarm” Rate-Hike Case Gains Ground Across U.S., Europe and Japan as Extreme Weather and Wars Fuel Inflation

Fed signals possibility of further tightening after holding rates steady in July
Global financial markets treat ECB and BOJ rate hikes as virtually certain
Heat waves, drought and military conflicts compound inflationary pressures worldwide

The world’s major central banks are accelerating their tightening timetables. With the U.S. Federal Reserve (Fed), European Central Bank (ECB) and Bank of Japan (BOJ) all leaving the door open to further rate increases, the center of gravity in global monetary policy is shifting markedly toward tighter financial conditions. The shift reflects renewed inflationary pressures as extreme weather and the Russia-Ukraine war constrain grain supplies, while disruptions to vessel traffic through the Strait of Hormuz drive up international oil prices and transportation costs.

The Fed’s Hawkish Message

Reuters reported on September 7 (all dates local) that central banks in the United States and other major economies were facing mounting pressure to raise interest rates. According to CME FedWatch, federal funds futures were pricing in an approximately 60% probability that the Federal Open Market Committee (FOMC) would raise its benchmark rate by 0.25 percentage points in September. The Fed’s increasingly hawkish message has reinforced market expectations of a rate increase. Although the FOMC voted to hold rates steady in July, a majority of officials agreed that further tightening could be warranted if inflation failed to moderate sufficiently. Three officials—Cleveland Fed President Beth Hammack, Minneapolis Fed President Neel Kashkari and Dallas Fed President Lorie Logan—dissented in favor of a 0.25-percentage-point increase.

Fed Chair Kevin Warsh likewise said in his Jackson Hole address on August 28 that “the relevant indicators are concerning from a price-stability perspective,” noting that “U.S. inflation continues to exceed the Fed’s 2% target.” He added that “although the latest readings were better than expected, it is difficult to conclude that the underlying inflation trend has improved meaningfully,” and assessed that “current financial conditions can hardly be described as restrictive.” Markets interpreted the remarks as a signal that the Fed was effectively keeping the door open to another rate increase. Prominent hawks within the Fed have also made more direct calls for tighter policy. Hammack argued on September 4 that monetary policy was not restraining the economy sufficiently and that prompt action was necessary, while Kashkari has maintained that a modest rate increase is needed to preemptively contain price pressures while economic activity and employment remain robust.

Europe and Japan Also Expected to Accelerate Tightening

For the ECB, which raised its benchmark rate by 0.25 percentage points in June for the first time in two years and nine months, another increase this month is now treated as virtually certain. In a Reuters poll of 65 economists conducted between August 31 and September 3, every respondent predicted that the ECB would raise its deposit rate by 0.25 percentage points, from the current 2.25% to 2.50%, on September 10. As of September 7, interest-rate futures were likewise pricing in a 0.25-percentage-point increase with an effective probability of 100%.

The probability of another BOJ rate increase is also considered high. On September 7, interest-rate futures were pricing in an approximately 75% probability that the BOJ would raise its policy rate by 0.25 percentage points, from the current 1.0% to 1.25%, at its September 17–18 monetary policy meeting. The probability of one further increase by December stood at approximately 60%. As expectations spread, financial markets have begun moving preemptively. On September 8, the dollar-yen exchange rate climbed to its highest level in six months, while positions in the yen carry trade—under which investors borrow yen to invest in higher-yielding assets—showed signs of partial unwinding.

Table 1. Interest-Rate Hike Outlook for Major Economies

Extreme Weather Drives Up Agricultural Commodity Prices

The reason central banks are accelerating monetary tightening is that inflationary pressures are intensifying worldwide. Agricultural commodities are among the principal categories driving prices higher. The climate crisis that has recently swept across major economies has caused severe disruption to global agricultural supply chains. In the United States, a prolonged drought has sharply deteriorated crop conditions across the Great Plains, a critical wheat-producing region. According to data compiled by the U.S. Department of Agriculture (USDA) in late May, 44% of the winter wheat then growing in the United States was rated “poor” or “very poor.” Drought.gov, the official drought information portal operated by the National Integrated Drought Information System (NIDIS) under the National Oceanic and Atmospheric Administration (NOAA), estimated that 70% of planted winter wheat in Texas, 47% in Oklahoma and 17% in Kansas would not be harvested. Even on fields where harvesting was successful, yields per unit of land declined year on year by 24% in Texas, 26% in Oklahoma and 27% in Kansas.

Extreme weather has also rapidly undermined crop conditions for major grains across Europe. According to the European Union’s (EU) Joint Research Centre (JRC), the hot and dry weather persisting since spring has placed winter wheat and other winter crops under pressure across Western, Central and Eastern Europe. Since June, the damage has spread to summer crops such as corn. Grain production forecasts have consequently been revised downward in quick succession. COCERAL, a European grain industry association, lowered its projection for this year’s grain production across the EU’s 27 member states and the United Kingdom by approximately 8.9 million metric tons, from 295.5 million metric tons in June to 286.6 million metric tons in July. The revised figure is approximately 23.4 million metric tons, or 7.5%, below last year’s output of 310 million metric tons. In its latest crop-monitoring report released on August 24, the JRC likewise projected yields per unit of land for major summer crops at as much as 14% below the five-year average.

Black Sea Wheat Supply Chain Effectively Paralyzed

The supply chains of Russia and Ukraine, which together account for approximately 27% of global wheat exports, have also been paralyzed by the war. Reuters reported last month that more than 97% of grain export facilities around the Black Sea and the Sea of Azov had ceased operations. Ukraine’s maritime export routes, in particular, have reportedly been almost completely cut off. Ukrainian Agriculture Minister Taras Vysotskyi said that not a single new vessel had entered the Port of Odesa between July 22 and mid-August. Ukraine is currently maintaining alternative export routes by transporting grain by rail to Eastern European ports or using the Danube River. These channels are also operating poorly, however, as a prolonged drought has lowered water levels in the Danube and railway maintenance problems have compounded logistical constraints across Eastern Europe.

Russia faces similar conditions. Major terminals in Novorossiysk, a critical grain export hub for the world’s largest wheat exporter, have suspended operations in succession. Following the Novorossiysk Grain Terminal (NZT) and Novorossiysk Grain Plant (NKHP), KSK—Russia’s largest grain terminal—halted grain intake and exports, while the Taman terminal also ceased operations. Some shipments could be rerouted through ports on the Baltic Sea, Caspian Sea or in the Russian Far East, but doing so would increase transportation distances and costs. Amid these logistical disruptions, Russia’s wheat exports contracted to approximately 1.8 million metric tons last month, the lowest monthly volume since 2010.

Energy Prices Remain Unstable

The Iran war is another factor compounding inflationary pressure. The Strait of Hormuz, which lies adjacent to Iran, is a critical conduit through which Middle Eastern crude reaches global markets, and vessel traffic has suffered severe disruption since the outbreak of the war. According to oil-market analytics firm Kpler, shipments of crude oil and petroleum products through the strait fell from 18 million barrels per day before the war to 2 million barrels per day by mid-August. Between August 28 and September 6, an average of 10 commercial vessels per day passed through the Strait of Hormuz, the lowest level since May, while no very large crude carrier (VLCC) had exited the strait since September 2.

The closure of the Strait of Hormuz has dealt a “devastating blow” to global energy supply chains. Since the outbreak of the Iran war, international oil prices have at one point exceeded $100 per barrel, while prices for petroleum products such as diesel and jet fuel have risen alongside refining margins. The International Monetary Fund (IMF) forecast that rising energy prices would increase costs across transportation, industry, petrochemicals and fertilizers, generating more broad-based inflationary pressures over time. It estimated that a sustained 10% increase in international oil prices could raise global headline inflation by approximately 0.4 percentage points. Taking these conditions into account, the IMF raised its forecast for global headline inflation this year to 4.7%.