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Risk of Inflation, Potential 'Commodity Shock': Analysts

Rising inflation in emerging markets, coupled with marked increases in commodity prices, could hurt developed economies, as companies struggle to keep input costs down while seeing precious investment dollars heading overseas, analysts told CNBC.

Close-up of a pen on stock price chart
Close-up of a pen on stock price chart

"I think it's the single most important issue that we face in the markets today," Philippa Malmgren, president of Principalis Asset Management, told CNBC. "We've got inflation ripping through the emerging markets. That's going to push input costs up for the entire Western manufacturing establishment."

The Federal Reserve committed to injecting a further $600 billion into the economy Wednesday, through the purchase of long-dated government bonds, in a bid to stimulate growth.

But the liquidity generated by the Fed's quantitative easing does not necessarily mean extra liquidity for the domestic U.S. economy, Hans Redeker, global head of foreign exchange strategy at BNP Paribas, told CNBC.

"What is happening is you create dollars, these dollars don't want to say in the United States. So you have a wave of dollar liquidity moving for example into the Hong Kong real estate market," he said. "We are creating U.S. dollar liquidity in the wrong places in the world."

That liquidity can have a negative impact in emerging market economies because of its inflationary pressures, Redeker said.

Those pressures will transfer to developed countries, where some companies can pass on the costs via higher prices to consumers; but that's not necessarily good for the economy overall as consumers have to pay more, Malmgren said.

"I think inflation is now absolutely with us, it's just not in our CPI (consumer price index) numbers in the West, but it's coming through the cost push," she said.

The impact of emerging inflation could be set to intensify because of a potential "commodity shock", according to Laurent Bilke, head of global inflation strategy at Nomura.

The prices of commodities such as agriculture and industrial materials are likely to rise, putting pressure on corporate earnings as well as individuals, he said.

"It is to some extent a shock to corporate productivity and a shock that will hit household real income," Bilke told CNBC.com.

Central banks in the developed world will be placed in a difficult position as they are faced with slow growth and rising inflation, he added. (Watch an animation explaining the inflation effect)

"The money will go anywhere other than where you want it and commodity prices have led the way, real estate is another," Simon Maughan, co-head of European equities, told CNBC.

Policymakers from emerging countries such as Brazil and China announced plans to curb capital inflows into their economies after the Fed decision because of the inflationary pressures and the impact on currencies.

Hot Money Adds to the Problem

Western cash could be adding to the problem as investors are eager to profit from the emerging growth story, Philip Poole, global head of macro and investment strategy at HSBC Global Asset Management, told CNBC.com.

"There is risk you manufacture the inflation elsewhere and then import back," he said.

There are three key sources of inflationary pressures in many emerging economies, according to Poole.

The first is food price inflation, then the effect of "unsterilized currency intervention," which is when central banks try to reduce a certain currency's supply in a bid to impact the exchange rate and the third is wage growth, he said.

Rising inflation will likely cause emerging markets to increase interest rates as central banks struggle to cool down their booming economies, Poole added.

"The problem, of course, is that raising rates when the Fed and other developed world central banks are on hold only increases the interest differential and the carry on these emerging currencies," he said.

"This potentially sucks in additional liquidity from the developed world, where (quantitative easing) and a deflationary overhang continue to push investors into emerging assets and currencies."

The more cash the Federal Reserve pumps into the economy, the more investors will use it to bet on emerging growth, which exacerbates the problem, Poole added.

The investment trend from the West to the East shows no sign of slowing, according to Robin Griffiths, technical strategist at Cazenove Capital.

"Some of the liquidity from the West is pumping up these markets," Griffiths said when discussing the emerging stock markets such as the Indian Sensex.

The Sensex has more than doubled in value since its multi-year low seen in March 2009.

Contact Europe: Economy

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