When the weather heats up, so can inflation

The UK has already seen unusually high temperatures this spring. I was at Kew Gardens with the family on bank holiday Monday when a new record May temperature of 34.8oC was set (which was then beaten the day after at 35.1oC).  However, it may be about to get hotter! Climate forecasters are increasingly confident that an El Niño weather pattern could develop this summer, with around an 80% probability of forming before September, and a high likelihood it persists into the year end.

El Niño is a naturally occurring climate event that happens every few years, when warmer ocean waters in the Pacific Ocean disrupt global weather systems. The effects can be wide-ranging, typically bringing higher temperatures globally, alongside both droughts in some regions and heavier rainfall in others.

Why this matters for investors

While this may appear to be a weather-related issue, El Niño has historically had meaningful economic consequences:

• Pressure on food prices

Changes in rainfall and temperature can disrupt agricultural production, particularly in key growing regions across Asia, Latin America and Africa. This can reduce crop yields and tighten supply, which may push global food prices higher.

• Increased energy demand

Hotter conditions often lead to greater demand for electricity especially for air conditioning in heavily populated regions such as Asia. This can support demand for power generation and fuels, particularly where renewable supply is limited.

• Inflationary implications

Higher food and energy costs can feed through into broader inflation. In turn, this can influence consumer spending, corporate profit margins and the path of interest rates, all of which are key drivers of market performance.

• Uneven global impact

El Niño does not affect all regions in the same way. Some economies may benefit from increased rainfall, while others face drought or heat stress. This creates divergence across emerging markets, which are those countries with less developed financial markets, but also has implications for global companies and UK-listed businesses with international exposure.

Key areas to watch

As the outlook becomes clearer, several important questions are likely to shape market sentiment:

• Will reduced crop yields drive food inflation meaningfully higher?
• Could an increase in demand for cooling boost energy markets, particularly gas and coal?
• How might extreme weather affect supply chains and production of key materials such as metals?
• What are the implications for sectors like insurance, where claims trends can shift with weather patterns?

At this stage, it is not driving large portfolio changes for us, but it is an important risk factor to monitor. We have been adding to the fund’s energy exposure, focusing on companies that can generate steady cashflows in different market conditions, and could benefit if energy demand rises.

At the same time, we remain cautious on the outlook for consumers. If inflationary pressures persist, this could weigh on spending. However, opportunities still exist where the price of company shares already reflect a challenging environment.