Some silver linings in a global meltdown

Published on Friday 24 October 2008 19:45

OVER the past three months, the outlook for global economic activity has significantly worsened. But, at the same time, the upside risks to inflation have largely dissipated and the prospects for lower official interest rates have clearly improved.

The key developments have been the sharp fall-back in oil and other commodity prices from their early-July peaks and, less happily, the re-emergence of serious strains in financial markets.

The fall-back in commodity prices is clearly good news for the economic outlook. The final surge in commodities in the first half of this year was speculatively driven and, as such, represented a negative shock to the global economy, undermining growth while at the same time pushing up inflation.

Conversely, one should welcome the unwinding which has seen the oil price fall back from $140 a barrel down to $65-$75 and the price of grain and several important metals drop by 30 to 50 per cent from early-July levels. Consumers' real incomes and spending should receive a boost while non-oil profits should also benefit. Central banks can also be much more relaxed about cutting official interest rates.

Financial developments continue to weigh heavily on economic activity. Market interest rates have risen sharply and corporate bond yield spreads have widened to new peaks; and the availability of credit has tightened markedly.

Looking ahead, the UK economy faces some serious headwinds: a depressed housing market and tight credit availability. Tightening lending standards for corporate borrowing is likely to make things difficult for firms that have borrowed heavily or have loans due soon. Yet most corporate balance sheets remain fairly healthy and, although profits are likely to fall in 2009, this is already being reflected in equity valuations.

• Richard Dingwall-Smith is chief economist at Scottish Widows Investment Partnership (Swip).