Bond and foreign exchange markets are currently discounting a significant slowdown in growth over the next 12-18 months and a continuation of a disinflationary environment.
This shift in market expectations was triggered by a combination of slower data in the US and China, concerns over sovereign risk in Europe and fiscal tightening in the UK and Europe. However, considerable uncertainty surrounds the level of trend growth in the UK, US and Europe post the 2007-2008 credit shock. This shock combined with various policy measures in the early 2000s may well have significantly reduced the trend level of growth so the actual output gap is smaller than policy-makers believe it to be. In such an environment, inflationary pressure will emerge sooner than expected....
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