[BillPaay]

The trend in commodity prices is important to watch due to the impact it may have on headline inflation. Food prices are more important for EM inflation, while energy prices are more significant for G10 inflation. If commodity prices stabilize at current levels the one off impact to headline inflation will be significant and will show up late in 2009/ early in 2010. However, if commodity prices stabilize here it is likely that the market will be able to see through it.

Things will become a lot trickier if commodity prices remain on an upward trend. This is because 'core' inflation pressures in several EM countries are likely to surface in response to the strength of final domestic demand. Real rates in EMs are extremely low. An increase in inflation, boosted by food prices, risk could speed up the reversal process in easy monetary policy. The key areas of pressure from food prices will be concentrated in Asia with Philippines, China, Indonesia and Taiwan experiencing a sharp reversal in their headline inflation trends, which, so far, have been for declining inflation for the most part. The tighter monetary policy typically translates to FX appreciation.