LONDON -- A food price crisis may be the next stumbling block for emerging economies, even as their bonds and stock markets rally in relief at an easing of the euro zone's debt crisis.
Wheat prices have jumped by more than 50 percent since June and are likely to rise further due to expectations of tighter supplies, triggering concerns about a repeat of the food crisis in 2007/08 that forced interest rates higher in many economies and led to emergency controls in others.
The UN's Food and Agriculture Organisation (FAO) cut its 2010 global wheat forecast by about 4 percent this week and said world wheat supplies may shrink next year if severe drought continues in Russia, Europe's leading wheat producer.
Russia imposed a temporary export ban on Thursday in response to a record-breaking heatwave and the extent of the damage to crops and its economy is only beginning to become clear.
Spiralling wheat prices could translate into higher inflation and possibly higher interest rates in emerging market economies, which tend to hold a large proportion of their consumer price baskets in food.
The FAO said healthy world stock levels should prevent a repeat of the crisis of 2007/08 but past squeezes on food have led some central banks to hike aggressively in a bid to head off a second round of price rises in their economies.
Analysts and investors are already preparing for tighter monetary policy in emerging economies, even as they look to the possibility of further quantitative easing in the United States.
"It is a big deal for emerging markets, though maybe not as big a deal as it was in 2006/7/8, as food prices make up 20-50 percent of emerging CPI baskets," said Charles Robertson, EEMEA chief economist at ING.
"Food prices never move in the U.S. as a result of changes in global harvests, because so much of the price of food is taken up by packaging, suppliers. In the EU, food prices move a little bit but in emerging markets, food price rises can add a few percentage points to the inflation rate."
Countries likely to be particularly at risk from high wheat prices include Nigeria, which has 25 percent of its CPI basket in bread and cereals, Robertson said.
Western economies typically have less than 20 percent of their CPI basket in food, compared with 30 percent on average in emerging markets, according to U.S. bank Morgan Stanley.
In Russia, higher wheat prices are contributing to speculation that the central bank will raise interest rates as early this year, after cutting 14 times since April 2009 to a record low refinancing rate of 7.75 percent.
Annual inflation in Russia is 5.5 percent.
"We see more upside risks...even a 15 percent inflation rate next summer does not seem unthinkable," said analysts at Danske in a client note.
Some central banks have already responded.
In India, a year-long spell of double-digit inflation, largely on rising food prices, sparked massive street protests.
One of a small but growing number of economies to have started raising interest rates, India has lifted its main lending rate four times by a total of 100 basis points since March, to 5.75 percent. Analysts say there is more to come.
However, an end to the El Nino weather pattern which led to the food price spike in India may actually reduce food price inflation in India, analysts say.
Higher inflation and higher interest rates tend to depress bond prices and can also affect corporate lending, eroding stock market gains.
Investors have flocked into emerging market debt this year, keeping spreads below the key 300 basis point level over U.S. Treasuries, in their search for higher yield without exposure to even riskier emerging equities. Any whiff of inflation is likely to turn those debt investors more cautious.
But currencies find an upside in higher rates, due to the relative appeal of holding deposits in higher-yielding markets.
The Ukrainian hryvnia, which has already shown some appreciation in recent months due to an improving economy, is singled out by analysts as likely to rise further.
The rouble may also be allowed to rise if Russia has to import grain, although Russian prime minister Vladimir Putin on Thursday imposed a temporary grain export ban.
"Countries that import food could be more open to allowing their currencies to appreciate in order to cope with higher food prices," said Elisabeth Gruie, emerging market strategist at BNP Paribas. "Eastern European countries such as Poland will be sensitive to the impact on higher food prices on inflation and could react by adjusting monetary policy."
Fuel and food prices took inflation to multi-year highs in central Europe in 2008, prompting rate rises, and there were also protests against rising food prices in many emerging market countries.
To grapple spiking food price inflation, several emerging food exporters, including Russia, Ukraine and Kazakhstan, introduced export duties in early 2008. Russia had already imposed price controls on basic foodstuffs in Oct 2007.
Wheat prices can also lead to higher prices of other food, as consumers switch to buying more rice, for example, putting upward pressure on currencies in the Middle East and Asia.
"Places like Egypt, India, Indonesia and the Philippines are pretty big importers of food," said Philip Poole, head of macro and investment strategy at HSBC Global Asset Management.
"Consumers are moving up the food chain in emerging markets, literally, that's putting the pressure on."
Additional reporting by Sebastian Tong; editing by Patrick Graham