WAR victory, but no victory rally; ever lower interest rates, but no surge in activity; booming government spending and borrowing, but no pick-up in growth. Welcome to the spooky global economy, 2003: a world of disconnection between event and consequence.
If Britain’s chancellor Gordon Brown had a problem on how to strike the right mix of policies to perk up business confidence last week, imagine, on a much bigger scale, the problems now facing the central bankers of the Group of Seven economies. Activity, confidence and investment continue to sag. But the central banks are fast running out of wriggle room to bring interest rates down further. Indeed, America has now reached a point where it has to think about other measures to take than further cuts in the Fed Funds Rate, already down to 1.25%.
Despite all the stimuli applied to the G7 economies over the past year, from the further loosening of monetary policy to big public spending boosts, stagnation continues to be the biggest single spectre haunting policymakers. Consumer confidence in America and Europe is under pressure despite the lowest rate of inflation and the lowest borrowing costs for decades.
A new wave of interest rate reductions - in America, Britain and Europe - will soon be upon us. But this, as they say, is a process, not an event. With the US Fed Funds Rate already down to 1.25%, there is very little wriggle room left. But it is not inconceivable that, by the end of this year, US rates could be close to zero, and with Fed officials resorting to some fancy footwork to engineer a further easing of monetary conditions. For once the Fed Funds Rate goes below 1%, further cuts are likely to encounter problems of credibility and confidence in the markets - and may end up having the opposite effect to that intended.
The dilemma the US now faces is tricky. The picture is less an unrelenting stream of bleak news but a more complex and ambiguous environment in which the downward drift is interrupted by better than feared numbers. In these circumstances it is difficult to disentangle short-lived fluctuations in data from the underlying trend. Market reaction can also be confusing: a rally, followed by a renewed and unsparing downward drift.
A good example came last Friday. After a week of rather uninspiring data causing US economy watchers to downgrade their growth forecasts for the first half of the year came surprisingly strong numbers on consumer behaviour that gave a sharp boost to the dollar - for a while.
March retail sales showed a 2.1% jump instead of the 0.6% rise expected. And the latest report on consumer sentiment from the University of Michigan showed a much bigger than hoped for rally. But after a brief fillip Wall Street went into retreat, cast down by sombre corporate trading news from companies as disparate as Boeing and Wal-Mart Stores. A massive slug of corporate earnings data is due this week. Be braced.
So the overall picture is by no means black. Indeed, it may well be that stock markets are overly discounting the worst. The Iraq war did not turn out to be anything like the grisly Vietnam/Stalingrad endgame feared by some. The oil price continues to fall - it is now down some 10% since the conflict began three weeks ago. And in geo-political terms the emphasis will now switch to peace, humanitarian issues and relationship repair.
‘Nothing seems capable of breaking the lower-for-longer outlook for the G7 economies’
But the most striking feature of the global economy is the absence so far any process or set of circumstances that gave convincing evidence of a strengthening recovery either this year, or, more worryingly, next. Last week investment bank HSBC cut its forecast for growth in US GDP to just 1.7% (from 2% previously. In 2002 the economy grew by 2.4%). For the UK it is forecasting 2.2% this year followed by1.5% next (clearly Brown’s budget forecast of growth next year between 3 and 3.5% has not bowled them over at HSBC).
The most dismal forecasts are reserved for the Euro-zone. The single currency area is forecast to manage growth of just 1% this year followed by 1.7% next, with growth in Germany following to just 0.4% and recovering to just 1.1% next.
What would make matters painfully worse for the Euro-zone would be a sharp dollar depreciation. Many believe one is due, and that it will take the euro dollar rate from $1.07 currently to as high as $1.20.
Those with long memories will recall that it was at the back end of 2001 that I warned of delayed recovery, that "2003 would be the new 2002". Two years later, despite all those cuts in interest rates in the interim, the prospect of recovery looks just as far off: 2005 looks the new 2002.
For the world’s finance ministers meeting in Washington this weekend, there just seems to be no countervailing pull to the anaemic growth outlook in the world’s biggest economy. Back in the 1970s we did the Locomotion: when America was slowing, Japan or Germany could be counted on to prevent a global downturn and help build the next recovery.
Not so now, Prospects for the Euro-zone and Japan are bleaker than ever. Little wonder there is growing frustration in Washington about the inability of the other major economies to help out, particularly when the US now has a burgeoning current account imbalance, and with the trade deficit set to balloon to as much as 7% of GDP.
So, back to the Fed. There is growing speculation that it is working on moves other than further rate cuts to ease monetary policy. These suggestions have been denied, but nonetheless the problem is evident. Indeed, the Fed’s reluctance to cut interest rates during the Iraq crisis and boost business and investor confidence rather testifies to an awareness that it is running out of rope.
Among suggestions around the markets to boost money supply is a Fed buying programme of long dated securities in open market operations. But the practical benefits may prove meagre while running the risk of undermining credibility in rate reductions when they do come.
Better, surely, a market-led reduction in long term interest rates than one induced by the bank. Indeed, the governor of the St. Louis Fed advanced such an argument last week. But as Stephen Lewis of Monument Securities points out, it also represents an argument against central banks ever pursuing an active policy. "That such an intelligent Fed policymaker should be driven to this desperate position demonstrates how little road to pursue an active policy the US central bank must now feel it has," he adds.
Nothing currently seems capable of breaking the "lower for longer" outlook for the G7 economies. The best we can reasonably hope for is central bank wriggling. Cramped though it may be, it may at least prevent this global stagnation from turning into something much worse.
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