Drought to lift food prices, inflation impact modest: KC Fed

Migrating shore birds feed in one of the few pools that have water at the Quivira National Wildlife Refuge in Hudson, Kansas August 7, 2012.

WASHINGTON (Reuters) - Americans will face higher food prices at the supermarket next year because of the worst drought in half a century, but the impact on overall inflation will be modest, the Kansas City Federal Reserve Bank said in a report.

It said the drought, which has cut corn and soy bean yields and sent their prices on the futures market soaring, could add 4 percent more to annual food prices over the next year, drawing parallels with a similar situation in 1988.

"Based on the relationships between the consumer price index for food and farm-level prices for crop and livestock, July's crop price increases and declines in livestock prices could lead to a 4 percent increase in the CPI for food from September 2011 to September 2012," the Kansas City Fed said.

The U.S. Department of Agriculture said on Friday this year's corn crop would fall below 11.0 billion bushels for the first time in six years and the number of bushels yielded per acre was a 17-year low.

Soybean production was forecast at a five year low and soy yield per acre nearly a 10-year low.

The drought will also affect meat and dairy prices as more than 70 percent of the beef herd is in states where pastures are rated as poor to very poor.

Heat stress has lowered milk production and rising feed costs are also pressuring hog and poultry producers, the Kansas City Fed said.

The initial effect will be low meat prices as farmers bring their animals to the market a bit early to cut losses from the high cost of feeds. In the long-term, however, a shortage of animals for slaughter will push up prices.

"A second wave of higher food prices tends to emerge from rising meat prices. Historically, within a year of a drought, the initial influx of meat supplies disappears and smaller breeding herds produce fewer slaughter animals and meat supplies shrink," the Kansas City Fed said

It said in 1989, livestock prices rose 8 percent, which contributed to a 10 percent increase in the CPI for meat in 1990.

"Surging crop prices in 2008 contributed to similar meat price shifts within a year. Historical patterns could re-emerge if livestock prices rebound in 2013 with shrinking herd sizes," the Kansas City Fed.

However, the impact on inflation is likely to be moderate, given that food accounts for 14 percent of the CPI.

"Thus, a 4-percent rise in retail food price inflation would contribute 0.6 percent to overall inflation. Higher food prices have little relationship to core CPI," the Kansas City Fed said.

The CPI increased 1.7 percent in the 12 months to June and food was up 2.7 percent.

(Editing by Cynthia Osterman)