Inflation fears mount as cotton prices hit new high

Poor harvests, soaring demand from China and market speculation have "exploded" the cotton market, traders say, with December future prices in New York hitting record highs of almost 120 cents a pound yesterday, before subsiding in later trading.

Cotton has thus punched through its previous historic high, seen in 1995, and is up by around a third on where it stood three months ago. Though the impact on retail clothing prices and the overall rate of inflation will be more muted (the raw material accounts for only a small proportion of the value of a finished garment), it adds to strong inflationary pressures in food and raw materials that will make the next few months uncomfortable for hard-pressed consumers, who are also facing an increase in VAT to 20 per cent in January.

The Bank of England's policymakers now face the prospect that inflation will stay stubbornly above the official target of 2 per cent next year, even as the economy slows more quickly than expected. The Consumer Price Index measure is already 3.1 per cent and the dilemma for the Monetary Policy Committee in preparing for its next announcement on 4 November is as acute as any in its history.

Plexus Cotton, one of the world's most important traders, said cotton futures had "exploded to the upside", though momentum might now start to slip. "The market doesn't look like it's done breaking records just yet," said the company. "We have now entered what appears to be the blow-off phase of this rally, with prices ascending in parabolic fashion."

The latest rally was sparked by a report by the China Cotton Association (CCA), which revealed that cotton imports reached 201,000 tons last month, maintaining the recent run of strong data, as demand for the crop runs at twice last year's pace. China is the world's largest importer of cotton. As the world economy has picked up, so has demand for cloth, shirts, hosiery and other products from China's bustling mills, especially from overseas. Demand in China is forecast by the US Department of Agriculture to rise to 10.9 million tons this season, from 10.7 million tons a year ago, creating a "severe shortage".

On the supply side, China also boasts the world's largest cotton crop, but this promises to be disappointing. The CCA has issued a fresh downgrade on its forecasts for the country's cotton harvest, and inventories held outside state stockpiles have almost halved. Production in Pakistan has also been hit by the floods. Cotton crops in India, China, Pakistan, Uzbekistan and the US are late by between two and six weeks.

Britain's shop trade will inevitably face increase cost pressures. Next and Levi Strauss have already announced price increases. A spokesman for Marks & Spencer said: "All retailers are currently facing increased cost pressures from rising cotton prices. Most of the industry expects prices to go up in the next six to 12 months but, of course, nobody knows what the future holds for cotton prices. What we do know is that we will do our best to avoid passing on any increased costs to our customers."

Clothing prices rose by 6.4 per cent between August and September alone – the largest on record for that period, according to the Office for National Statistics. It compared with a rise of 3.6 per cent between those months in 2009. Such pressures seem more likely than not to intensify, and to increase the squeeze on household budgets, in turn adding to the downward forces facing the economy as its struggles to grow.

Plexus also confirmed the role that speculators are playing in the recent cotton boom, just as they have been identified as contributory factors in the inflation of other commodities, from gold to oil and coffee. "The keen interest in cotton by speculators and hedge funds is not surprising given the current macroeconomic environment, in which nearly all commodities are rising while the US dollar keeps falling," the company said.

"Although the current bull market in cotton has its foundation in an extremely tight supply/demand scenario, the ongoing debasement of the US dollar is certainly playing an important part as well."