Tuesday, May 4, 2010

Inflation differential between developed and emerging markets

The risk of a large deflation has passed with the growing recovery across the globe. The risk of inflation in developed countries has also passed as the near-term fear that QE would lead to an inflation spiral has also passed. What has gone somewhat unnoticed has been the growing differential in inflation between the developed and emerging markets. The IMF projections provide a perfect view of the growing gap.

Inflation in the G3 is no non-issue. We still see deflation in Japan. The US has shown stubborn inflation of around 2.5%. Now look at the inflation in other parts of the world. It is down from a few years ago, but it now rising and much higher than the developed world by more than two times. The recovery is stronger but the tie to the US exchange rate has allowed liquidity into these countries. This has to be sterilized. Rates are rising in these countries which is starting to affect capital flows and the potential direction of exchange rates.

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