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Amara Sriphayak, head of the Bank of Thailand's domestic economy department, has signalled that we should not be surprised to see double-digit inflation in July and August although average inflation for the year would still be below 10 per cent. Should we be surprised?

No, we shouldn't. But we'll be surprised if the central bank lies back and does nothing in the face of severe upward price pressure.

Higher oil prices are driving runaway inflation. If the oil price reaches US$160 (Bt5,351) a barrel, the inflation rate in Thailand would certainly be in the double digits for the whole year. The question is how the banking authorities or the government should deal with inflationary pressure, the likes of which hasn't been seen since the economic crisis more than 10 years ago.

As this round of price pressure represents cost-push inflation arising from the higher oil prices rather than the supply side, many economists, such as Nobel Prize laureate Joseph Stiglitz, believe that raising the rates would not solve the problem. Worse, it would further deal a blow to economic growth and cut job creation.

The Finance Ministry and the National Economic and Social Development Board appear to have adopted a similar line of thinking.

But the financial markets think otherwise. Phatra Securities, in its report, "Thailand Economics: Reluctantly Raising Rates", (published on Friday) notes that it expects banking authorities to raise the policy rates by one full percentage point over the next 12 months. It believes that the policy rate will increase by 50 basis points in the second half of 2008 and another 50 basis points in the first half of 2009.

"The moderate rise is meant to preserve GDP growth, which we project to decline slightly to 4.6 per cent and 4.7 per cent respectively in 2008 and 2009," the report said.

The Bank of Thailand has become more hawkish. Governor Tarisa Watanagase, once again, will have to walk a delicate line. The Finance Ministry will not give the central bank a blank cheque to raise interest rates in the midst of a sour business climate and at a time when consumer confidence is low and economic growth sluggish.

But the central bank has already raised its guard high. It now considers maintaining stability the country's number one priority. As core inflation might exceed 3 per cent in June, the central bank will have to raise its policy rate at its meeting on July 16.

Some have argued that a normal 25-basis point rate hike might not be enough. Citigroup, in its "Emerging Markets Daily" report on Friday, said it believes the Monetary Policy Committee might go for a 50 basis point rate hike.

This would be aimed at dampening expectations of higher inflation. If everybody believes that prices will go up, they will raise prices or hoard goods in anticipation of more expensive items. Daily wage-workers would also demand a hike in pay. Expectations of inflation then become self-fulfilled. The job of the central bank is to kill such expectations and return public sentiment to normal.

"We continue to believe the duration of the expected rate tightening cycle would be limited to the second half of 2008 with policy rates raised to 4 per cent to 4.25 per cent. Likelihood of the monetary tightening cycle in Thailand ending late second half of 2008 with the bias shifting back to neutral would depend on inflation peaking in the fourth quarter of 2008," Citigroup said.

"This assumes a relatively benign oil price outlook in the prevailing range with limited downside. With recent remarks of an Opec official expecting oil prices at US$150/bbl to US$170/bbl in the third quarter of 2008, local markets might assign a larger upside bias to Thailand's monetary policy outlook. Unless we see strong evidence that private spending would stall as oil prices drift up, the policy rate outlook would be wary of the risk from higher oil price effects."

We also hold the belief that authorities mustbe wary of the risks from the results of higher oil prices. They must dampen inflation expectations and tackle the problem now rather than leave it for the future and suffer for it, as Vietnam has done.