Merrill says global inflation risks being ignored

NEW YORK (Reuters) - Policy-makers and investors are ignoring the risks of surging food and energy prices, which threaten to spark an inflationary spiral in emerging economies and restrict growth in developed countries, according to a Merrill Lynch report released on Friday.

"For the first time in our memory, inflation, not growth is the primary macro driver at the global level," wrote Merrill Lynch's global economics team in a research report.

"The inflation shock has already happened," they wrote. This week, U.S. crude oil surged to records above $135 per barrel, sparking a bond market sell-off that drove benchmark U.S. Treasury note yields near their highest levels year-to-date.

"What matters now is how persistent it (the inflation shock) is and how markets and policy-makers react; at a global level this begs for an accident that will awaken markets and policy-makers to the risks," an event that is likely to happen in the second half of 2008, wrote Merrill.

Merrill has sharply raised its 2008 forecast for global consumer price inflation to 4.9 percent from its prior forecast of 3.4 percent last November.

Investors should purchase protection against the danger of inflation accidents, one reason being that "bond yields globally should adjust higher as these risks unfold," Merrill wrote.

"Inflation supports commodities, inflation-linked fixed income, appreciating currencies and emerging market infrastructure," Merrill wrote.

The report suggests that by and large, investors and central banks are only just starting to face the possibility that the current climb of energy and food prices may now become a sustained trend that will change the long-term inflation outlook.

"One cannot but be struck by how widespread the view is that inflation is a problem, but one that will fade over time even though policy-makers are not expected to act aggressively as they view this as an exogenously driven shock centred on food and energy prices."