Gold soared to within a few dollars of its highest price for seven years yesterday as speculators gambled that inflation - and not deflation - is now stalking the world economy thanks to a recovery and bulging government deficits.

The gold price shot up by $10.50 to $371.50 an ounce, its highest level since May and just below the seven-year high of $378 reached in February.

The immediate trigger was the expiry of options contracts in New York, but nearly all the world's major central banks are
locked in a battle to hold their currencies down to see off deflation, or continuously falling prices. The US Federal Reserve continues to warn of a possible "unwelcome fall" in inflation.

However, some investors are starting to believe that central banks have gone too far and may set off price rises on the high street. Furthermore, governments around the world have started to run up massive deficits.

This week, the US Congressional Budget Office warned that the American government deficit could be as much as $401 billion (£255 billion) this year. Higher inflation could be good for the gold price. Gold is unlikely to be devalued as it does not depend on any central bank or government for its value.

John Reade, an analyst at UBS, said: "The market hit important technical levels yesterday and could now rise further. The investors we are talking to are now looking through the short-term risk of deflation and focusing on economic recovery and reflation. I think people are losing faith in the ability of politicians and central bankers to keep inflation under control."

Evey Hambro, who manages the Merrill Lynch Gold & General Fund, said: "The market has been like a pressure cooker and the lid blew off today. It takes place against a background of rising government deficits. Unlike paper currencies, you can't just run gold off the printing press."

Central banks are the biggest holders of gold and have a pact to limit their sales. There are hopes that at the International Monetary Fund meeting in Dubai later this month the pact could be renewed on stricter terms.

Source--money.telegraph.co.uk