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El Nino is coming

Economic forecasters are currently preoccupied with falling oil prices and the implications for global growth, weather forecasters worry about the impact that an El Niño event could have on global weather patterns.

M&G Investments logoIn August, America’s National Oceanic and Atmospheric Administration (NOAA) said there was a 90% chance that the current El Niño event will continue through the remainder of the year, resulting in a 2°C rise in temperatures. Bill Patzert, a climatologist with NASA’s Jet Propulsion Laboratory, has described the current event as “Godzilla El Niño”.

Could such an extreme weather event have macroeconomic consequences? The short answer is, yes. In a recent paper from the IMF, economists Paul Cashin, Mehdi Raissi and Kamiar Mohaddes investigated the effects of El Niño events on growth, inflation, energy and food prices in a recent paper. Based on a sample of 21 countries, the authors found that the economic consequences of these weather events can indeed be statistically significant.

Countries negatively affected by El Niño from a growth perspective include Indonesia, Australia and New Zealand. Hot and dry summers in Australia cause a rise in the number of bush fires, leading to a fall in wheat exports and a rise in wheat prices. New Zealand also experiences a drop in agricultural output as the country is faced with both floods and drought. Drought is harmful to the Indonesian economy as well, with prices rising for commodities such as coffee, cocoa and palm oil.

However, some economies may actually benefit from an El Niño event. While droughts in the northern parts of Brazil could drive up prices for coffee, sugar and citrus, this is mitigated by wetter weather in eastern Brazil, boosting agricultural output. More importantly, trade spillovers with other nations suggest a positive overall effect for the Brazilian economy.

In Mexico, El Niño is associated with fewer hurricanes on the east coast bringing stability to oil production. Wetter weather in California is expected to benefit certain crops, while the US economy could also benefit from warmer winters in the northeast, increased rainfall in the south, and fewer hurricanes on the east coast.

Higher temperatures and more droughts are also expected to affect commodity prices. There is likely to be a higher demand for both coal and oil due to the reduced capacity of thermal and hydroelectric power stations, with the authors concluding that crude oil prices can sustain a statistically significant uplift following an El Niño shock.

Extreme weather conditions also have the ability to restrict the supply of agricultural commodities, creating food price inflation and higher overall inflation. This is especially the case for countries where food accounts for a high weighting in the CPI basket, such as Mexico, Brazil and Indonesia.

If the “Godzilla El Niño” takes hold as the NOAA expects, the global economy is likely to be hit by short-run inflationary pressures, as global commodity prices rise. However, the effects on economic growth will differ across regions, with some countries actually benefiting through higher demand and increased production.

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The views expressed by external contributors are not necessarily those of Old Mutual Wealth or Old Mutual International.

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