The Inflation Merry-Go-Round

Spyros Andreopoulos & Joachim Fels, Global Economics Team, Morgan Stanley

The last two to three months have seen the growth outlook for the global economy solidify and inflation return to the forefront of investors' attention. Initially supported by successive rounds of QE, inflation expectations in the developed economies have recovered - in part with inflation itself. Inflation has climbed further above target in the UK, has moved above the ECB's upper limit of slightly below 2% in the euro area, and is likely bottoming in the US. In addition, commodity prices have rallied, partly in response to the inflation/growth outlook (in the case of oil and some hard commodities) and partly in response to one-off supply disruptions (many agricultural commodities).

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FX: Euro Catches a TailWind

Arne Lohmann Rasmussen, Senior Analyst, Danske BankSince 13 January when the ECB made the market aware that its focus was once again on inflation, the euro has strengthened substantially, with EUR/USD climbing from below 1.30 to above 1.37.

The hawkish tone of the ECB stood in stark contrast to the US central bank's message on interest rates in the past week. The FOMC made it clear that it has no plans to roll back the current accommodative stance on US monetary policy. With unemployment still high and underlying inflation tracking south, the outlook is for the current Treasury buyback programme not to be terminated ahead of time and the first rate hike to be still a long way off.

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U.S.: The Stage is Set for an Economic Expansion

John E. Silvia, Chief Economist, Wachovia

Real GDP grew at a 3.2 percent annual pace in the fourth quarter, which pushed the level of output to $13.38 trillion, slightly surpassing the peak of $13.36 trillion reached in late 2007. While the headline was weaker than expected, the devil is in the details. The disappointing headline figure was depressed by a significant pullback in inventories, which shaved an eye-popping 3.7 percentage points off real GDP. Inventories are typically a wild card in forecasting and are notorious for delivering surprises. In contrast, consumer spending surged 4.4 percent, the strongest annualized rate of growth in nearly five years. Net exports also increased with exports far outpacing imports, which contributed another 3.44 percentage points to economic output. While headline real GDP and its underlying components are sending somewhat mixed messages, the true strength in the economy can be found in real final sales, which jumped by 7.1 percent.

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United States - Optimism in the Near Term Economic Outlook

Christos Shiamptanis, Economist, TD Bank Financial Group

While stock markets rose throughout most of the week, buoyed by a surfeit of optimistic data on various fronts, they gave most of their gains on Friday on heightened geo-political uncertainty. The most anticipated economic release of the week was the GDP report, which revealed that the recovery is shifting up a gear. U.S. real GDP grew by 3.2% in the fourth quarter of 2010, supported by strong gains in consumer spending and net exports, offset only by a dramatic pullback in the pace of inventory accumulation.

Led by a 21.6% rise in durable goods spending, personal consumption expenditure (PCE) grew at 4.4% in Q4 - its highest pace of growth since the first quarter of 2006. And the good news does not end there, as consumer confidence data for January revealed that the spirits of American consumers continued to rise into the new year. While balance sheet deleveraging will continue to weigh on spending growth in 2011, growing optimism coupled with tax stimulus, improvements in income growth and a large degree of pent-up demand for consumer durables should support consumption growth of around 3.0% through the year.

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Focus Turns to Growth

Lloyds Bank Corporate Markets

International bond yields rose further last week as firmer growth signals from the US, China and Germany and inflation signs in the UK added to fears of policy tightening. This week provides key releases for markets to digest. The US FOMC announcement on Wednesday will eclipse President Obama's State of the Union address in financial market's eyes. First estimates of Q4 GDP are due both from the US and UK. UK markets will also pour over the minutes to January's MPCmeeting.Domestic interest rate expectations rose further last week and UK SONIA swaps now fully price a 25bp rate hike by mid-year and the possibility of two more rate hikes by November. Minutes to January's MPC meeting on Wednesday will be scrutinized to validate this hawkish rate profile. The headline vote is likely to remain unchanged.

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Compiled by Michael Wright, Currency Analyst

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