Global industrial output – as proxied by combined production in the G7 and seven large emerging economies – is back on its post-2000 trend path, having staged a V-shaped recovery since early 2009. The "E7" have accounted for 60% of the rise in combined output, with production now well above trend in these economies, explaining recent evidence of "overheating" – see first chart.

Rapid E7 growth fuels inflation partly by boosting food demand and prices. A GDP-weighted average of E7 consumer price inflation moved above 5% in October and should rise further as a result of recent food commodity price gains – second chart. (The average weight of food in the CPI baskets of 120 non-OECD countries was 37% in 2006, according to a 2008 IMF study.) Pressures, moreover, may be spilling over to non-food prices – see last week's post on Chinese inflation.

E7 central banks have been trying to tighten monetary policies without jacking up interest rates, which have risen meaningfully only in India and Brazil. An average of E7 short rates remains well below inflation, with the gap widening recently – third chart. This policy approach may have reached its limit. The last tightening cycle, in 2007-08, ended only after the average interest rate had risen above headline inflation.

E7 growth outperformance since early 2009 has been supported by faster monetary expansion but real M1 has slowed recently, narrowing the gap with the G7 – fourth chart. Rising inflation and further policy tightening – particularly if in the form of higher interest rates – could sustain this trend, in turn suggesting that E7 relative economic performance will be less impressive during 2011. Emerging market equities may not be priced for this outcome, currently trading on a higher price to book than developed markets.