Institutional investors are concerned about worldwide currency misalignment amid growing gloom over the global economy, but are relatively sanguine about inflation, according to Merrill Lynch’s Survey of Fund Managers for April.

“At a time when G7 policymakers have been warning that excess volatility and disorderly movements in exchange rates are undesirable for economic growth, investors have signalled that they believe exchange-rates have already departed from fundamentals,” it notes.

The firm reports that April’s results are some of the most extreme currency readings in the survey’s history: 50% of asset allocators regards the U.S. dollar as ‘undervalued’, up from 30% three months ago. In contrast, 71% see the euro as over-valued, up from 55% in January. More worrying, it suggest, is that 52% of investors still believe that UK sterling is overvalued despite its recent collapse.

“Investors are beginning to acknowledge sterling’s biggest depreciation against other European currencies since 1992,” said David Bowers, independent consultant to Merrill Lynch. “What is striking is investors’ fear that further decline is still to come, thereby resulting in their taking an even greater bearish stance on U.K. equities.”

Fearful of further currency losses, global asset allocators continue to shun the U.K. stock market in spite of the broader global equity rally of the past month, it says. Their underweight position on U.K. equities is at a four-year high and is the second most aggressive that the survey has recorded, as 31% of asset allocators are now underweight U.K. equities compared with a net 17% in March.

Merrill says that one puzzle this month is the extent to which global investors remain comparatively relaxed about inflation despite persistent rises in commodity prices, including those in the eurozone. The survey suggests that eurozone investors remain highly consumed by the outlook for growth, and appear to have become oblivious to the risk of inflation. The number of investors who expect core inflation in the eurozone to rise in the next 12 months has fallen to just 2% in April from 20% in March.

As a result, European investors are pulling back from the commodity-based stocks they have relied on to capitalise on rising inflation, especially over the past year. Investors have slashed overweight positions in Basic Resources and Utilities and reduced their overweights in Oil & Gas.

“A degree of profit taking makes sense given the gains we have seen in sectors such as Basic Resources. But the question is whether these inflation-sensitive stocks have truly lost their market leadership,” said Karen Olney, chief European equities strategist at Merrill Lynch. “A wholesale change out of commodity-exposed stocks would coincide with the view that inflation is cyclical rather than secular.”

Investors have redeployed proceeds by reducing underweight positions in Retail and Automobiles and by making a significant move back into Insurance.

A lack of fear over inflation is also echoed in Asia. The number of investors in Asia (excluding Japan) who expect inflation to rise over the coming year in April has fallen sharply to 15% in April from 63% in March. “We think inflation, not a sharp drop in growth, remains the key macro risk for China and the region,” said T.J. Bond, chief economist for Asia-Pacific (ex-Japan), Merrill Lynch. “Unfortunately, we do not expect inflationary pressure to abate soon.”

A total of 202 fund managers participated in the global survey from April 4 to 10, managing a total of US$659 billion.