Central Banks

Global inflation is reawakening to test central banks and markets

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Global central banks have spent trillions of dollars and the years since the financial crisis battling to ward off deflation and with mounting signs that their efforts are now paying off, inflation numbers are a key market focus Tuesday.

Despite the strengthening trend in data seen in recent months, rhetoric from central banking chiefs continues to be tilted away from pursuing swift actions to address rising prices and instead directed towards prioritizing other economic imperatives. Meantime longer-term bond yields in key global markets have been on a mostly steady march higher since last summer.

Inflation data out of China on Tuesday surprised to the upside with spikes in energy costs leading the way, helped by food and tourism. Yet the People's Bank of China looks set to maintain its focus on containing leverage and preventing bubbles over targeting inflation – and according to some economists, is right to do so for now.

Explaining that the timing of the New Year holiday played a role in boosting the latest data, Julian Evans-Pritchard, China economist at Capital Economics, expressed skepticism that the high data points will last in a note on Tuesday.

"The base effects that have boosted inflation in recent months are soon going to go into reverse. Meanwhile, tighter monetary policy, slowing income growth and cooling property prices should keep broader price pressure contained over the medium-term," he posited.

A similar pattern is expected in the U.S., where despite core inflation surprising to the upside in December in hitting 2.2 percent, the first few months of 2017 see a high bar given strong data recorded in the same period last year.

Economists at SocGen see headline inflation spiking to 2.6 percent in February and March before dropping to a stable level of around 2.0 percent from the spring and falling further due to higher energy comparables from 2016 later in the year.

"Still, the annual average CPI is likely to be about 2.0% in 2017 versus 1.3% in 2016," notes Omar Sharif, Senior U.S. Economist at SocGen, in recent research.

The economy and markets can handle this level, Rick Lacaille, global chief investment officer (CIO) at State Street told CNBC's Squawk Box on Tuesday.

"On the US I think we'll see a little bit more core inflation but frankly we don't think that's going to be a real problem," he predicted.

Fed Chair Janet Yellen is widely expected to continue pointing towards the data dependency for the central bank's rate rise agenda this year. This as the market's current pricing in of a June and December hike sits at odds with the latest indications from the Fed's ratesetters that there may be three rises this year, one as early as next month.

The unknown variable is the extent to which President Trump proceeds with his reflationary proposals, driven by boosted fiscal spending and resulting in speedier interest rate ramp-ups accompanied by a stronger dollar.

The euro zone presents a more complicated picture for European Central Bank (ECB) chief, Mario Draghi with increasing calls out of Germany for higher rates and a stronger currency contrasting with the needs of the weaker member states.

"If you look at the euro zone landscape overall I'm not sure you see quite so many inflationary signs and I think that puts the ECB in a little bit of a dilemma with push and pull coming from different parts of the union," said Lacaille.

Despite consumer price inflation jumping over expectations to hit 1.8 percent in January, Draghi recently said the ECB would need to see underlying inflation show more of a sustained uptick before tightening policy.

Indeed, overall the return of inflation is good news for Europe, Mouhammed Choukeir, CIO at Kleinwort Hambros told CNBC on Tuesday.

"Actually it's good everywhere at the moment because inflation is around the 2-3 percent mark. Clearly if it runs higher than that and central banks don't act then it becomes a major risk," Choukeir affirmed.

Until Tuesday's weaker-than-expected inflation read of 1.8 percent, the situation in the U.K. pointed towards pricing pressures stemming from the beleaguered sterling potentially forcing the Bank of England to reconsider its pledge to "look through" a certain amount of inflation in favour of supporting the economy. Despite this month's disappointment, however, the data still reached its highest point since the summer of 2014.

Overall, looking at the impact of inflation on global markets, State Street's Lacaille was sanguine.

"Is it going to be a headache for investors? No. Will you see rising real yields and break-evens in the next two years? Yes."

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