On the first full trading day of the year, there was no escaping the scent of inflation. In the UK, it was the VAT rise to 20%, along with rail fare increases and fuel duty, all within the space of four days. Furthermore, the latest survey of inflation expectations reflected a worrying jump, rising to 3.5% for the year ahead (currently CPI is 3.3%). In the eurozone, the 'flash' estimate of December inflation came in higher than expected, jumping from 1.9% to 2.2%. We also highlighted yesterday the worrying rise being seen in Asia and China in particular, where the headline numbers are underestimating the true extent of inflationary pressures. But compare and contrast. In the UK, wages are lagging some way behind and the majority of the inflation is cost-push, as a result of rising commodity prices and also indirect taxes. In China, wage increases are being pushed through, whilst changing consumption patterns are having a structural impact on prices. Tighter monetary policy may serve to temper some of this, indeed it may well be preferred to exchange rate appreciation. In the UK, higher rates will have little impact, apart from possibly undermining the already fragile and fiscally constrained recovery. This year could well be one of even more marked divergences between the fortunes of the developed and emerging worlds.

Telling Tuesday. From one respect, Tuesday was just another day, but in markets, it was the first full trading day of the new year. This meant new money and new benchmarks, so moves can sometimes be instructive. For fx, the most interesting angle was the pressure seen on high yielding currencies (Aussie, Kiwi), alongside the Swiss franc. At the same time, gold took a beating, seeing the largest one-day fall for around two months. Meanwhile, equities were rising modestly in European (UK FTSE aside, which was up nearly 2%). What does all this tell us? It's obviously early days, but the sense is that investors are not willing to pile into the dominant themes of last year, at least not yet. A tougher ride for gold would fit with the real interest rate story we pointed out just before Christmas.

European funding kicks off Portugal is to sell 6-month Treasury bills to the market today in what will be the first test of investor appetite ahead of the large amount of refunding that has to take place in the early part of this year. This sort of sale tends to be taken up largely by domestic banks, so is really a warm-up act to the EUR 20bn of bonds that will have to be sold this year. For now, the euro has gained some reassurance with China stating its confidence in the Spanish debt markets early on this week, but there are huge hurdles to overcome and the single currency will be vulnerable to any refunding wobbles.

Rising inflation expectations a worry for UK MPC. One of the concerns that many observers had regarding the extended period of elevated inflation in the UK was that it would ultimately result in raised inflation expectations. Well, there is now unambiguous evidence that this is happening. According to the latest YouGov/Citi survey, inflationary expectations for the year ahead rose to 3.5% in December, up from 3.3% in the previous month and 2.7% back in July. This is one development that the Bank's policy-makers will take notice of. Interest rates at both the short and long end of the yield curve were higher on Tuesday, in part because of this concern about inflation expectations. All else being equal, higher expectations of inflation raise the prospect of an interest rate hike from the MPC in coming months.

UK recovery looks resilient. The UK's manufacturing sector continues to register positive surprises. In December, the manufacturing gauge produced by the Chartered Institute of Purchasing and Supply rose to 58.5, from 57.5, the highest reading since 1994. This survey is consistent with other recent reports which indicate that the manufacturing sector is benefiting from the strength of foreign demand, the competitiveness of the pound, and respectable demand at home. Separately, the Bank of England reported that the number of mortgage loans rose to just slightly above 48K in November, broadly in line with the average of the past six months. Consumer credit fell in the month, the third decline in the past six months, as households continue to pay down debt.

Eurozone inflation above target. The surprise increase in eurozone inflation to 2.2% puts it above the ECB's target for the first time in two years. Furthermore, it undermines the notion that fiscal austerity would keep a lid on inflation. Indeed, Greek inflation at 4.9% goes some way to debunk this myth. Inflation rates in the core remain more subdued, apart from Belgium, at 3.1%. We've got to wait for further detail on this number but, as with the UK, rising indirect taxes and food prices are the sort of inflation the ECB can do little about in the short-term.