Soaring grain prices are attracting a lot of attention in markets at the moment. Given the strong role that food prices played in emerging markets in the inflation spike of 2007-08, attention naturally centres on the role of food inflation. Is food inflation likely to push headline CPI inflation significantly higher? Are policymakers poised to head off any potential threat from food price inflation aggressively? We asked our EM country economics teams to give us their assessment of the impact of high food prices and how central bankers will approach this
issue.

The collective opinion suggests that food prices, despite their large weight in headline inflation, are unlikely to cause a large impact on headline numbers. In addition, central banks are probably willing to overlook food price inflation to ensure further consolidation in growth, with the notable exception of India and a growing risk of monetary intervention in Indonesia.
With sufficient domestic stockpiles and a slowing global economy, central banks are unlikely to be aggressive in hiking rates. But slow action could allow food prices to spill over into prices of other items, raising the risk that central banks will have to deal more aggressively with this more general increase in prices further down the road.

David Fuller's view Food inflation remain a sensitive issue in developing economies because despite the emergence of a significant and growing middleclass in recent years, the number of poor people remains higher. The average household in developing countries pays more for food as a proportion of its income than in the West. However wheat prices are likely to have a much greater impact in the West. Asia, for instance, would be more adversely affected by a spike in the price of rice, which has yet to occur.

I think analysts in the West are paying insufficient attention to commodity price inflation generally. Whether this is due to a preoccupation with other factors or a delayed reaction to changing circumstances, economists and markets may be in for a shock.

The standard mantra in the reports and comments that I see remains: 'There is no inflation; deflation is the problem.' These economists are looking at stubbornly high unemployment, weak GDP growth and debt deleveraging by consumers. They also listen to the Fed, see the quantitative easing and the deflation-discounting decline in government long-dated bond yields. Never mind that this latter trend is due to QE, recapitalisation of banks via the yield curve and momentum buying.

US-centric observers are paying insufficient attention, in my opinion, to strong GDP growth in many progressing economies with large populations. Their economic expansion is leading to greater demand for most commodities. Also, western economists have yet to factor in the USD's renewed weakness as a factor behind commodity price inflation.

If the USD remains soft, developing economies continue to grow and the West avoids a double-dip recession, as I expect, then commodity price inflation is likely to return before yearend. The two wild cards in this scenario are the degree of adverse weather affecting crop yields and the amount of commodity speculation that occurs.

Whatever, I think we will hear more about stagflation in the months ahead, as Eoin and I have been mentioning recently. This would be an unpleasant 'surprise' for bond markets where yields are increasingly discounting continued disinflation or outright deflation. Breaks in the downtrends for government bond yields, when they occur, will likely provide additional support for stocks leveraged to the global economy, as some momentum traders sell debt and buy equities.

While other factors - known and perhaps unknown - will also be an influence, stagflation may not be bearish for equities until the Fed is several steps into its next cycle of higher interest rates. Historically, the US central bank has been reluctant to raise short-term rates until unemployment is clearly trending lower.

I will review more charts of commodity prices tomorrow.