By K.T. Arasu

CHICAGO (Reuters) - After a breather on Friday, U.S. grain markets are likely to resume their scorching drought-fueled rally this week with a U.S. government report on Wednesday expected to give price direction even as hot and dry weather remains center stage.

The 30 percent summer rally in Chicago Board of Trade corn futures sparked by one of the worst droughts in nearly a quarter century in the U.S. grain belt could add to food inflation not just in the United States but across the globe.

And meat companies like Smithfield Foods and Tyson Foods could see margins being crimped, raising the prospects of consumers having to dig deeper into their wallets even as concerns over global growth escalate.

Weather in the U.S. Midwest, which grows about 80 percent of the corn and soybeans in the United States, has been key in the rally that began about three weeks ago and there is little relief in the cards for this week, forecasters said.

Some analysts are expecting corn futures to blow past their current record high price of $7.99-3/4 per bushel set in June last year and soybeans to move above its peak of $16.63 set in July 2008, in the coming weeks if the drought persists.

On Friday, spot July corn futures closed at $7.43-1/4 per bushel and July soybeans at $16.19-3/4 per bushel.

Analysts are also expecting the surge in prices to affect a policy change in the ethanol industry that mandates companies to produce 12.6 billion gallons of the fuel additive this year.

"The market's goal seems to be to change the ethanol mandate policy," said grains analyst Dan Basse, president of research firm AgResource Co. in Chicago.

"EPA (Environmental Protection Agency) has the authority to change the mandate," he said.

Basse said that based on weather conditions and feedback from crop scouts, the corn yield this year could fall to below 140 bushels per acre -- compared with the U.S. Department of Agriculture's current estimate of 166 bushels.

He said CBOT corn futures were trading on expectations that the yield was around 147 to 148 bushels per acre.

A Reuters poll of 13 analysts this week showed the yield to be 153.4 bushels per acre, down 2.5 percent from a similar poll a week ago.

USDA TO CUT CORN YIELDS?

Analysts were expecting the USDA's July crop report to be issued on Wednesday to revise down its yield estimate, but added that the department was unlikely to adjust it in one fell swoop.

There could be a further revision in August when the USDA conducts field surveys and has more data available.

"They have to take a whack at yield and total supply to soften the blow of the drought," said grains analyst Mike Zuzolo of Global Commodity Analytics in Lafayette, Indiana.

"I also expect them to substantially take down demand," he said, adding that high corn prices had already dented demand for the grain from the ethanol and export sectors.

He said some of his livestock clients were contemplating liquidating their hog herds if the drought in the Midwest persists and continues to raise feed costs.

Darrel Good, agricultural economist with the University of Illinois in Urbana-Champaign, said some of the corn crop in parts of southern Indiana and southern Illinois were damaged beyond recovery by the heat and dry weather. Continued...