Asia's emerging market central banks will need to keep ratcheting up interest rates well after inflation peaks to prevent higher prices from seeping into corners of the economy where they are much harder to dislodge.
Two months after global oil prices began to subside from a spike fed by Middle East unrest, the worst appears to be over for China, Indonesia, and a handful of other Asian economies that struggled to contain inflation this year.
But it may be only a short-lived reprieve. Home-grown inflationary pressures are building, stemming from tight labor markets, rising property values and growing domestic demand, meaning rate rises may continue at least through 2012.
China is the country to watch. Not only is it the biggest player on the block, but it has become a role model for some other policymakers in the region and a bellwether for investor sentiment on Asian emerging markets.
We do expect inflation to roll over in the coming months, Frederic Neumann, co-head of Asian economics research at HSBC, said in a telephone interview from Hong Kong. But make no mistake, there is underlying inflation that will not disappear in China.
Neumann thinks last week's interest rate hike from the People's Bank of China (PBOC) will be the last of the year but far from the final move of the tightening cycle.
A slim majority of economists polled by Reuters on Thursday predicted otherwise, calling for one more one-quarter percentage point increase in bank lending rates by year end.
Benchmark interest rates across Asia remain well below levels that prevailed before the financial crisis exploded in 2008, which argues strongly for more tightening. In India, South Korea and Malaysia, for example, interest rates are running below annual inflation.
Neumann and others worry that easing price pressures may lull policymakers into a false sense of security. Indeed, Malaysia's central bank held rates steady last week, defying expectations for a rise.
That is one reason why economists are looking for evidence of inflation lurking beneath the surface.
Similar to the way U.S. economists strip out food and energy prices to focus on core inflation, Asia economists are differentiating between cost pressures emanating from globally traded commodities and those tied to domestic factors.
A simple headline-versus-core comparison is not as useful in emerging markets because food and energy consume a much larger portion of household budgets than in advanced economies.
Focusing on home-grown versus imported inflation can offer clues about which way inflation is headed, and reveal hot spots that might otherwise be masked by moderating headline rates.
TROUBLE ON THE HORIZON?
China's annual inflation hit a three-year high in June, data released on Saturday showed. Falling world commodity prices suggest that may be as hot as it gets, at least for this year.
International crude futures prices are down 15 percent since May 2. Surveys of purchasing managers show China's factories getting some relief on raw materials costs. Australia looks set for a bumper wheat crop after several disappointing harvests, U.S. corn supplies appear ample, and India's monsoon season started early.
The trouble is, just about everything else is heating up. Non-food inflation rose 3 percent in June from a year earlier, the biggest gain since records began in 2002.
A breakdown of China's inflation data shows swift gains this year in categories such as consumer goods, clothing and home appliances and maintenance.
Chi Sun, a China economist at Nomura in Hong Kong, sees evidence of structural shifts in inflation that will persist long after global price pressures subside.
Rising land prices and labor costs mean domestically produced food prices may continue to climb even if bumper harvests abroad bring down global markets, she said.
Then there is China's medium-term economic policy, laid out in its recent five-year plan. Among Beijing's goals is to raise the minimum wage by at least 13 percent per year, totaling 84 percent by 2015. Rising wages are part of the reason why Nomura sees one more PBOC rate hike this year, and four in 2012.
China is not the only Asian economy that may need to tighten beyond the peak in inflation. The latest reading out of Indonesia showed annual inflation at a one-year low, cementing economists' view that Bank Indonesia will hold fire at its next policy-setting meeting on Tuesday.
Indeed, Bank Indonesia is sitting pretty compared with its peers in China and elsewhere, with economic growth still on the upswing while inflation fades, said Bank of America-Merrill Lynch economist Chua Hak Bin in Singapore.
That may quickly change.
Chua pointed out that oil-producing Indonesia artificially tamps down inflation by subsidizing fuel prices. The country is also overdue for electricity tariff hikes.
The government has set a lofty goal for 2012 economic growth -- as high as 7 percent -- while Bank Indonesia lowered its inflation target zone by one-half of a percentage point to 3.5 percent to 5.5 percent, he said.
Strong growth and higher domestic energy costs are a recipe for higher inflation that could easily outstrip the central bank's lowered target.
Latent price pressures are brewing, (and) will eventually show up, Chua said. Enjoy the sweet spot for the rest of this year, for now.
For investors, inflation remains one of, if not the, biggest threats to the Asia growth story. Fears that China will over-tighten and inadvertently choke off growth have soured some foreign investors on the entire region.
Markus Schomer, chief economist at PineBridge Investments, said he was underweight on emerging markets largely because of that inflation worry.
When China's inflation rate turns lower, that will be the signal to get back into emerging markets, he said in an interview in Singapore, where he was visiting clients.
Schomer thinks Singapore may serve as an early warning system for the path of inflation across Asia. It was the first in the region to pull out of the slump after the global financial crisis struck, the first to suffer an inflation spike, and the first to see price pressures abate, he said.
That is probably because Singapore is a global trade hub which makes it highly sensitive to shifts in the world economy.
Singapore's next installment of inflation data comes on July 25, but the figures so far this year show the rate topped out at 5.5 percent back in January, a good six months before the rest of the region is expected to peak.
Standard Chartered cautioned clients not to assume the turn in inflation signals the end of interest rate hikes.
Investors looking for a quick policy reversal are likely to be disappointed, economists wrote in a research note.
(Reporting by Emily Kaiser; Editing by Neil Fullick)