The world economy is powering ahead at a faster pace than expected two months ago, building up global inflationary pressures, the chief economist of the International Monetary Fund said on Tuesday.
Inflationary dangers pose the greatest risk to the rosy world outlook. But so far rapid gains in commodity prices, now spreading from metals and energy to food and agricultural products, have not pushed up consumer prices broadly, Simon Johnson said at a news briefing.
There are real inflationary pressures when you run a world economy this fast, Johnson said at a briefing where he forecast global growth of around 5 percent this year.
The United States, Japan and Europe are no longer benefiting from falling prices for imported goods, which adds to inflationary dangers associated with fast growth, he said.
Despite these pressures, Johnson said: We see very little inflation feeding through.
He expressed confidence that as long as major central banks remain focused on containing inflationary expectations, price risks should not unravel the robust global outlook.
It depends on monetary policy, if monetary policy remains credible, and the Federal Reserve and the European Central Bank are rightly focused on that, he said.
ECB monetary policy is consistent with this robust growth, he added.
Testimony to confidence that inflationary pressures will remain under wraps is the adjustment in bond prices recently. Johnson said the steepening of the yield curve reflects higher expectations for higher nominal rates - or in the Fed's case no rate cut - not higher inflationary premia.
The yield on the 10-year U.S. Treasury note rose above 5 percent this month for the first time since July 2006 as investors scaled back expectations for a major U.S. slump that would prompt the Fed to cut rates from the 5.25 percent level.
Similarly, 10-year European government yields have risen above 4.5 percent for the first time since late 2002 on robust economic data, which heighten chances for ECB rates to rise above the current 4 percent level.
Markets have held up well to the bond market adjustments, which claimed a victim in Bear Stearns' hedge funds. Johnson described this as a test case for how portfolios are unwound.
GLOBAL GROWTH AROUND 5 PCT
Johnson said that global growth, forecast by the IMF at 4.9 percent for this year and next in its April outlook, is likely to come in a little stronger around 5 percent.
Europe and emerging markets are performing better than expected, while the U.S. is a little weaker although it should rebound in the third and fourth quarter, he said.
For the euro zone, Germany's strong performance after years of structural reforms is brightening the overall outlook. The region is also reaping the benefits of economic and monetary integration, he said. The IMF expects to revise upward slightly its current GDP forecast of 2.3 percent for 2007 and 2008 to somewhere in the region of 2.3 to 2.5 percent, he said.
That would be roughly in line with ECB staff forecasts for 2.6 percent GDP this year and 2.3 percent in 2008.
As for the euro currency, Johnson said that on a trade-weighted basis he considers it fairly valued in the medium term. He would not discuss bilateral rates such as the euro-yen rate
Building inflationary pressures globally should provide room for the Bank of Japan to raise its benchmark interest rate, which in turn would gradually reduce the yen carry trade and help redress global imbalances, he said.
Inflation around the world will allow Japan to raise nominal rates, he said without giving a timeframe. Nearly half the economists in a Reuters poll on Tuesday forecast the BOJ would raise rates from 0.50 percent by August but uncertainty persists over BOJ timing.
Higher Japanese rates will provide room for the Japanese yen to appreciate in value, Johnson said. He was not concerned it could also bring a turbulent unwinding of the carry trade, financed by very cheap Japanese money, noting that the yen has fluctuated broadly without major fallout in markets.
We think that the global economy can withstand fluctuations. We are energized by the fact, Johnson said.