Between the lines: Speculating on recovery is a business with big risks

Published on Thursday 7 May 2009 21:35

HAVE we reached the point where we can see, not necessarily the economic recovery itself, but the conditions arriving which will allow the recovery to start?

There are, at first sight, encouraging signs – stock markets rallying around the world, banks such as Barclays reporting profits, commodity prices rising – which lead some to think recovery will happen soon. Sorry, but I don't think so.

Latest to join the ranks of the cautiously optimistic is Jean-Claude Trichet, president of the European Central Bank (ECB). At a press conference in Frankfurt yesterday, he said: "The latest economic data suggest tentative signs of stabilisation at very low levels after a first quarter that was significantly weaker than expected."

He added: "Inflationary pressure has been diminishing as money and credit growth have further decelerated. That was why the ECB felt able to cut eurozone interest rates by a quarter point to 1 per cent."

The receding threat of inflation also seems to have persuaded the ultra-cautious Germans to accept that the ECB should engage in monetary expansion by buying around 50 billion of covered bonds (corporate bonds which are considered to be extra safe because they are covered by a borrower's pledge, backed by insurance, to repay).

What was highly interesting about these announcements was that they represent a decision to follow the aggressive and faster moves in this direction by America's Federal Reserve and the Bank of England.

The ECB has been reluctant to follow suit, fearing that inflation will be the result and that interest rate rises to choke off that inflation will also have the effect of stifling any recovery.

But given the recent chill warnings that the supposedly more robust eurozone economies (as opposed to the shaky British and American economies) will contract by between 3.8 and 4.2 per cent this year, and warnings that the deflation is more likely to occur than reflation, some caution has been thrown to the winds.

For better or worse, the monetary authorities in Britain, the US and Europe are all now travelling the same policy road, the difference only being the speed at which they are moving down it.

The point of these actions is, of course, first to reduce the cost of borrowing money to both individuals and companies and, secondly, to inject more lending capacity into the financial system by exchanging illiquid assets held by financial institutions with cash that can be lent out.

Once credit starts moving again in reasonable quantities, economic recovery should be on the way.

One sign that it might be happening is that the interbank lending, or Libor, rates have fallen. The three-month dollar Libor rate is now just below 1 per cent, the lowest since the measure was introduced two decades ago, and more importantly, narrowing the spread over base rates to levels not seen since the credit crunch began.

If you recall that it was banks' lack of confidence in each other (because of the amount of dodgy securities they might have on their books) which caused the credit crunch and which was measurable by soaring Libor rates, then the regaining of banks' confidence in each other looks like a significant step towards recovery.

The world's stock markets seem to be already factoring in a recovery. The principal European and American indices have risen 20-30 per cent since the lows of early March, suggesting that the investment managers whose job is to spot trends before they become apparent to you and me think that the worst may be over.

Commodity prices also seem to be on the way up. Since hitting bottom in late January, the price of metals has risen 3-5 per cent, and the price of crude oil has jumped more than 20 per cent. This week, Brent crude hit a six-month high of $56 a barrel.

There were all sorts of contrary explanations for this rise, but the basic truth is that people are bidding up the price of oil and other commodities because they think that the demand for them is about to increase. And that must mean they think the end of the recession is nigh.

I'm afraid I disagree. There is nothing restricting the supply of crude oil, despite Opec's best efforts, or increasing the demand for oil (rising unemployment and reduced trade is cutting the use of refined oil by all forms of transport) to suggest that the oil-price rise is real.

What there has been recently is a prediction by Goldman Sachs that, by the end of the year, oil will be at $60 a barrel. Since the same people also predicted last year that oil would hit $150 a barrel, promptly producing an unsustainable price bubble, I suspect the same process is at work again. In other words, I fear that speculation rather than real positive developments in the world economy is driving these apparently positive price movements and creating a false dawn.

I'd like to be wrong about this, but I rather suspect that the ECB will have to throw more caution to the winds before light dispels the present gloom.

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