Global markets uneasy over inflation

Tuesday, 25 January 2011 00:01 - - {{hitsCtrl.values.hits}}

LONDON (Reuters): Investors may be forced to rethink investment strategies that centre on the rosy prospect of low inflation as key central banks look set to renew pledges to print money in the coming week.

Outperformance of developed market assets relative to their oversubscribed emerging counterparts this year partly reflects a sentiment shift for investors, who are becoming uneasy about inflation in the rapidly growing developing world and an as-yet muted policy response.

Price pressures are becoming increasingly observable even in developed economies. UK inflation hit an 8-month high of 3.7 percent last month, prompting investors to price in a rate hike by mid-year.

Higher energy prices have pushed euro zone inflation to 2.2 percent, above the European Central Bank’s 2 percent target.

But there’s nothing to suggest these central banks will tighten monetary conditions aggressively.

The Fed and Bank of Japan are expected to stick to their quantitative easing policies when they meet in the coming week while the Bank of England minutes are likely to reveal no change in its promise to keep its asset purchasing programme on standby.

Even the ECB, whose President Jean-Claude Trichet has warned of price pressures, is unlikely to raise rates immediately.

However, further price pressures may challenge the investor perception interest rates would remain at current low levels for a foreseeable future -- which could in turn hit equities.

“You don’t have runaway inflation expectations. No one expects the ECB to be very aggressive. With this golden period of no interest rate rises, investors have no choice but to buy risky assets, exactly what central banks are engineering us to do,” said Gary Baker, head of European equity strategy at BofA Merrill Lynch.

“But if there were anything to challenge the U.S... rates outlook, that may be a signal to start to get cautious on positions.”

A net 72 percent of fund managers polled by BofA Merrill Lynch this month expected higher inflation in the next 12 months, the highest reading in almost 5 years.