There are increasing signs that economies across the globe are re-flating. China and the UK both recorded elevated levels of inflation in January. In China the rate rose to 4.9 per cent on an annualised basis and in the UK inflation picked up to 4 per cent, its highest rate since November 2008.

So what does this inflationary trend mean for investors? Due to the fragile state of the economic recovery, especially in the West, the outcome for financial markets is fairly cloudy. But it should mean that bond yields are likely to rise in countries where inflation is a problem, which should boost the local currency. So far central bankers haven't shown themselves to be too keen to raise rates at all (UK's case), or not at a fast enough clip to halt inflationary pressure (China's). This should help the outlook for the global economy, at least central bankers don't look like they will tighten too much to choke off growth - well, not yet anyway.

In the aftermath of the UK inflation release Gilt yields actually fell and the pound remains lower versus the dollar after reaching as high as 1.6100 early in the European session. This could be due to two factors: firstly, although inflation was high in January, it was in-line with expectations and so didn't surprise the market, secondly that investors are re-assessing their positions prior to tomorrow's Inflation Report at 10.30 GMT, where Mervyn King will deliver his growth and inflation expectations for the next two years. This will help steer the market's interest rate expectations. The paring back of short Gilt positions, which has pushed yields lower today, could be some investors fearing that King won't be as hawkish as some expect, instead he will signal a delay before increasing rates until the autumn when the growth picture becomes clearer.

It will be a volatile few days for the pound, but the FTSE 100 is trading well after Barclays reported stronger than expected earnings, surprising the market. This kicked off bank results season in Europe. Due to the predominance of the financial sector in the FTSE 100, it makes up more than a fifth of the index, these results should be closely watched by investors.

The markets' reaction to Chinese inflation was fairly muted, however the Hang Seng was down nearly 1 per cent. But overall risky assets performed well. The euro has reversed part of yesterday's losses and the dollar is weaker. The Aussie also held up fairly well. Although Chinese inflation wasn't as strong as the 5.4 per cent expected, at 4.9 per cent annual rate it suggests that the pace of rate hikes could start to accelerate. This might hurt risky assets in the medium-term, however, right now there are no signs that the Chinese authorities will slam on the brakes hard enough to disrupt its behemoth of an economy from continuing to grow strongly.

In Europe, the peripheral economies are once again the missing pieces of the growth puzzle. While Germany's economy grew at 4 per cent last year, the fastest pace since reunification, the Greek economy shrunk by a massive 6.6 per cent. This uneven pace of growth is not healthy for the Eurozone in the long-run, but although it makes the prospect of a default by Greece more likely in the medium term, the markets will be breathing a sigh of relief that Germany (Europe's largest economy) is extremely strong and thus can afford to help its neighbours. We still don't know just how far Germany will go to support the other Eurozone members, a finance ministers meeting ended yesterday with no further clarification regarding a long-term rescue facility. The euro continues to extend gains, and is currently above 1.3500 versus the US dollar. The driver has been a general shift back into risk along with German 2-year bond yields bouncing off their recent lows on the back of its stronger GDP data.

European stock markets are higher along with gold. Gold has surged possibly as reaction to the stronger inflation data, since the yellow metal is traditionally an inflation hedge.

Data watch:
13.30 US Retail Sales Last 0.6 Exp 0.5
13.30 US Retail Sales Ex Autos Last 0.5 Exp 0.6
13.30 US Core import prices Last 1.1 M/M 4.8 Y/Y Exp 0.8 M/M 4.4 Y/Y
13.30 US Non Petroleum Import prices Last 0.4 M/M 2.7 Y/Y Exp 0.5 M/M 2.7 Y/Y
13.30 US Empire State Manufacturing Index Last 11.92 Exp 15.0
14.00 US TIC Data Last 85.1 Bio Exp 40.0 Bio
15.00 US Business Inventories Last 0.2 Exp 0.7
15.00 US NAHB Housing index Last 16 Exp 16
15.00 US Pianalto Speaking
18.00 US Geithner speaking on OBAMA FY2012 Budget proposals
23.50 JP Tertiary Industry Index Last 0.6 Exp -0.6

Best Regards,
Kathleen Brooks| Research Director UK EMEA |
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