LAST week, for the first time in 15 long months, the light at the end of the tunnel looked no longer like that of an oncoming train. In America and Britain, markets powered upwards.
This was on something more than relief over better-than-feared economic data. It was on a growing hope that an all-out Depression has been avoided. We have been delivered from a condition with which many in the business and financial world will immed
iately identify: what Marco Annunziata, chief economist at UniCredit, described last week as "long months of stress and oppressive depression".
The spreading of the belief that the worst is over is in itself likely to do more than further bouts of quantitative easing and fiscal stimulus to bring a halt to recession by the year end. Recovery is something else. But that alone is an enormous psychological advance on where we were just a few weeks ago. As US Fed chairman Ben Bernanke may have muttered to himself last week: "Miracles we can do. The impossible takes a little longer."
What has caused this pronounced change of mood in markets, and in so short a time? And can this uplift in confidence be trusted? The past 12 months have seen two relief rallies in markets founder on further bank shocks and a freezing of credit markets. What's so different this time?
For the past six weeks economic and business confidence data have pointed to a softening in the ferocity of the recession. House prices, retail sales and business order books were still falling, but at a slower pace. Talk of "green shoots of recovery" was still being met with hoots of derision. But as we entered the second quarter of the year the view that "less negative is positive" began to gain ground. So vertiginous were the plunging charts on orders and business confidence in January and February that there seemed every possibility we were heading for a Depression comparable in length and depth to that experienced in the 1930s.
By the end of April that sense of foreboding had begun to lift. Last week brought a clutch of pointers that the slackening rate of attrition might be something more than a temporary lull in the storm. In America, closely watched surveys of the stricken housing market showed further evidence of a turning point being reached. Consumer confidence showed a tentative revival. And banks were also displaying further signs of recovery, albeit under mountains of toxic debt and problem loans.
However, if things are now going so swimmingly, why did the Bank of England judge last week that the economy was still in need of further monetary stimulus through an additional £50 billion boost to quantitative easing? This announcement caught markets by surprise, and suggested that the Bank did not share the surge of optimism that we may now be past the worst.
There are two reasons for the Bank's additional QE boost. The first is that while we may indeed be "past the worst", that is not at all the same thing as a return to growth. The process of hauling the economy out of the trough is going to be long and will require further substantial boosts to banks' balance sheets. We are not near the point at which the Bank can safely judge that the economy can return of its own volition to pre-crisis levels of lending and growth.
The second is that the Bank's Monetary Policy Committee may still be in recoil from the over-optimistic forecast in February. This was that the UK economy would decline by just three per cent this year and rebound to growth of 2.3 per cent in 2010. The Committee would have been shocked by the ferocity of the 1.9 per cent first-quarter decline in GDP, taking the fall in the year to the first quarter to 4.1 per cent.
The MPC may perhaps be a bit more confident that recovery will eventually come. But its statement last week appeared to hint that it has postponed its forecast for recovery from the second half of this year to somewhat later.
Might it also be that QE is not working as it should? Given that the asset purchase facility was only launched in March, it is too early for any authoritative judgments to be made over the effects of the scheme. According to calculations by Investec economist Philip Shaw, by early April banks had passed £14.4bn of the £26.5bn of QE liquidity then provided into interbank markets. "Hence, on these figures, less than half of the QE cash is being hoarded at the BoE. QE does seem to be having some positive effects and we would hope that there are firmer signs of more liquidity filtering through into the 'real' economy in due course." At its current rate of purchases, the BoE should have finished implementing the rest of the £125bn of QE by the latter half of July.
Meanwhile, as the data flow from the economy continues to improve – "less negative is positive" – more sanguine forecasts for the UK economy next year are likely to gain ground. Lombard Street Research in its quarterly UK economic forecast out this weekend, reckons that the scale of corporate retrenchment in the first quarter was greater than it expected and its earlier forecast of a 3.1 per cent GDP decline this year may prove too optimistic. However, it still believes the rate of decline will moderate sharply in Q2 to minus 0.4 per cent, and that the economy should expand by 0.9 per cent in 2010 – close to Chancellor Alistair Darling's Budget forecast of 1.25 per cent growth.
"These forecasts," it says, "imply a total recession of four per cent over four quarters from 2008 Q2 to 2009 Q2, somewhat more than the 1974-75 recession, less than that of 1980-81." The chief risk to this forecast is external – particularly, says LSR, from the Eurozone. Mediterranean Europe "is a disaster zone in desperate need of devaluation with tighter monetary policy, but unable to have it. Germany meanwhile insists on budgetary rigour, making its recession twice as bad as Britain's." Plus ça change…
Trends in the real economy never proceed in a straightforward, linear fashion. The troughing out of this cycle will be no different, with conflicting signals over the next six months and lag indicators such as unemployment reminding us that the human cost of this recession will continue to rise as the stock market senses recovery 12 to 18 months ahead. However, barring some ghastly new skeleton crashing out of the banking cupboard, à la Lehman Brothers, the last seven days is set to go down as the week the world turned.
The full article contains 1136 words and appears in Scotland On Sunday newspaper.
