A strong drought in China - the world's largest producer of wheat - will weaken the supply of wheat to the global market and has helped push wheat prices to their highest since 2008. At the same time that there is poor growing weather, there has been an increase in demand from places like Bangladesh, Iraq and Algeria, to quell pressure on governments from local unrest.


As we can see from this weekly chart, we have seen an 83% increase in wheat prices since last year and that has pushed up the cost of inflation around the world. It has led to shortages for basic staples like bread and has fermented unrest in several countries.

Here is the jump in wheat today.


From BloogingStcoks.com:

On Wednesday, the United Nations' Food and Agriculture Organization (FAO) issued a notice that severe drought in China's main winter wheat region could pose a serious threat to output, as reported in the Wall Street Journal. Some 5.2 million hectares out of the total of about 14 million hectares could be under threat from poor rainfall and low snow cover.

A lack of bread and higher bread prices have been cited as a factor in the protests that have spread through Tunisia to Egypt and others. Because of that countries are increasing their demand in order to help lower local prices.

The United Nations said that food prices reached a record last month according Bloomberg. We have seen countries trying to battle inflation by raising interest rates - the most recent example being China's hike of its benchmark lending and deposit rate.

More from Bloomberg:

The drought in China's wheat-growing regions may worsen rapidly as the weather gets warmer, the Ministry of Agriculture said Feb. 4. The drought affected 35 percent of wheat crops in eight provinces as of that date, it said. On the weather front, the drought in China is at center- stage right now, as wheat is starting to come out of dormancy, Paris-based farm adviser Agritel said in a commentary today.

Chinese wheat output may have dropped to 114.5 million tons at the last harvest, compared with 115.1 million tons a year earlier, according to U.S. Department of Agriculture estimates. Macquarie expects output to drop a further 4 million tons this year. The USDA will update its outlook today.

Impact on Central Bank and Currency Markets

Higher wheat prices are a symptom of generally higher commodity prices. We have seen this higher food inflation and commodity inflation working its way into the developed countries like United Kingdom and Euro-zone, not to mention the emerging market economies, and will create some impetus for central bankers to move on interest rates. The prospect of higher interest rates and more hawkish central bankers would work to boost the EUR and GBP. For now the Fed is content with their loose policy and so the USD will be sold, especially in an environment when commodities and equities are rallying on risk appetite.

Still, part of the effect of this is higher bread prices, and this drought in China will only increase upward pressure on the price of wheat.