Recession signals we can't afford to ignore

WHEN all else fails, clutch at straws. Such is now the desperation amid deepening pessimism in the United States and Europe about economic prospects. Neither interest rate cuts nor, in the US, a $150bn fiscal stimulus, has helped to ease the downpour of data suggesting that the world's biggest economy is already in recession.

But first, a straw to clutch. About the only item of encouraging news from the US in the past week was a report from the Mortgage Brokers Association. This showed mortgage applications had risen in the week to February 1 to the highest level in nearly four years. The MBA's seasonally adjusted index of applications, which includes both purchase and refinance loans, rose 3%, its highest since March 2004.

An end in sight, then, to America's housing debacle? Don't cheer too soon. While mortgage rates have fallen along with US Treasury yields in recent weeks, analysts warn that the data may have been skewed by prospective borrowers filing multiple applications to obtain a single loan due to widespread tightening of lending standards. The MBA data counts all applications, including borrowers who are ultimately denied.

And on almost every other front, from service sector surveys to car sales, from supermarket sales figures to consumer confidence, it seems that even the Federal Reserve's dramatic interest rate slashing will not avert a slide into formal recession.

Here are five key pointers:

• Rising unemployment: while new applications for US unemployment benefits fell by 22,000 in the past week, the number of workers remaining on jobless aid rose to its highest level in more than two years. Unemployment is a 'lag' indicator, one of the last to respond to an economic downturn, so there are widespread fears that these numbers are going to get worse. Ian Shepherdson, US economist for High Frequency Economics, says: "In this environment, simply cutting back on hiring will not be enough for companies to maintain earnings as demand slows. Jobs will have to be cut too."

• Weak retail data: the ABC News/Washington Post Consumer Comfort Index plunged six points last week and has fallen 13 points so far in 2008 to hit its lowest level since 1993. And the news flow from retailers is not good. Wal-Mart Stores, the world's largest retailer, reported a lower-than-expected 0.5% rise in January sales and said it expects same-store sales for this month to come in between flat and up 2%. Toiletries group Limited Brands reported an 8% fall in same-store sales and warned of a drop in February. Gap, Target Group and JC Penney were among other big stores reporting disappointing results.

• Poor service sector data: January survey data shows that US non-manufacturing firms reported a plunge in activity, orders and employment despite the Fed's two latest rate cuts. Veteran Wall Street watcher Ed Yardeni, who has been taking a sanguine view of the depth and length of the US downturn, said: "I nearly fell off my chair when I read about the ISM non-manufacturing survey. It was ugly. It suggests that all the respondents concluded in January that we were in a recession." Only three industries reported growth in January: utilities, professional scientific and technical services, and educational services. Fourteen other industries contracted, ranging from construction and property through transport and warehousing to entertainment, recreation and the retail trade.

• Car sales downturn: US car sales fell into a ditch in January, with seasonally adjusted sales down to the lowest in two years and well below December's level. Domestic car sales dropped from 5.6 million units in the final months of 2007 to 5.1 million in January.

• Slow turnaround in housing: Even if the up-tick in mortgage applications is sustained, it is going to take some time to work through to a rise in new house starts. Housing starts are forecast to fall 20% this year, according to a report from the National Association of Realtors last week. The group also said its index of pending house sales for December fell 1.5%, slightly more than economists expected. A US government official meeting with analysts last Thursday counselled patience in forecasting an economic turnaround, even with the rate cuts and stimulus package.

What does this imply for the UK? One clear message is the speed at which the downturn has set in. Households and businesses alike have picked up the worries from the financial sector quickly and are not at all sure that even fast-track rate cuts by the US Fed will avoid a hard landing.

One particularly worrying feature of the pessimism psychology is that downward trends in the economy are almost automatically expected to continue, while reasonably robust company earnings are dismissed as historic with no relevance to what is about to strike. This helps explain the viciousness of the falls in many sectors of the stock market and the short-lived and tentative nature of the rallies. It has become common to see days starting with a surge in the Dow Jones or the FTSE 100 but ending with vicious falls in both.

One evident worry for the UK is that the glacial pace of rate-cutting by the Bank of England's Monetary Policy Committee may have little effect. The housing and construction sectors will continue to turn down, and it is hard to see an immediate uplift to consumer spending from the two quarter-point reductions already announced.

A particularly depressing piece of analysis doing the rounds in the US last week was the thesis of 'double dip' recession: that after a short-term fillip as the fiscal stimulus package takes effect later this year, US consumer spending will relapse in 2009. This assigns little efficacious power to the Fed's rate cuts, despite their size and swiftness.

For now, pessimism prevails. If you see a straw, pass it on.