Don't stamp out success by rushing economic recovery efforts

The financial markets have called the end of the recession. Commodity prices are soaring, stock markets are up, bond yields are rising, interbank lending costs are falling and sterling is in the ascendant. There is growing optimism that the quantitative easing programmes launched in the US, UK and the eurozone, allied with $1.5 trillion of spending increases and tax cuts over the coming 18 months, will spur recovery.

But is it all too good to be true? The fact is that those investors who are now jumping back in were battered by a slump in the prices of almost all asset classes over the past two years. They are terrified of missing the turning point.

'You can't wait for the good news,' says one battle-hardened fund manager. 'If everyone knows the good news, the market will be high and you will have missed out on much of the uptrend.'

One of the most striking recoveries is in the oil price, which has more than doubled since hitting a four-year low of $32.70 a barrel in February 2009. 'Oil prices have gone from strength to strength in recent months,' the International Energy Agency says in its June monthly report, which raised its forecast for demand for crude this year.

But the IEA, which advises OECD countries on energy policy, says that while the latest surge in prices was 'partly fuelled by signs of slightly stronger fundamental factors', there was evidence of speculators piling into the market. According to the US Commodity Futures Trading Commission, futures contracts by 'non-commercial investors' – speculators – have shifted from a net 11,000 short positions in early May to a net 48,000 long in June.

Barbara Lambrecht, an analyst at Commerzbank, says that many of the factors that drove last year's boom are present again – specifically a resurgence of geopolitical factors.

'Political unrest following the presidential elections in Iran and bombing attacks on oil plants in Nigeria represent an explosive mix for the oil market,' she says.

Price recovery
Oil is not alone in pricing in recovery. The price of copper, lead and nickel all rose by between 13% and 20% in the month to 15 June after falling as much as 50% in the previous 12 months. Meanwhile a basket of foodstuffs tracked by Commerzbank is up 3% over the same period.

And if commodity prices are rising, then inflation may not be far behind. The bond market certainly thinks so. Yields on 10-year government bonds, which act as a market measure of interest rates, hit 4% on both sides of the Atlantic in June.

Analysts say the so-called 'bond vigilantes' – investors perpetually worried about rising inflation and ballooning budget deficits – are sending out warning signals that central banks must soon start hiking interest rates to quell a sudden spike in inflation.

The net effect has been to offset some of the benign impact of the quantitative easing programmes that were designed to bring down market interest rates. For example, the rise in UK yields from around 3% at the start of 2009 flies in the face of the £125bn of extra liquidity announced by the Bank of England aiming to push bond yields down.

'Though policymakers have attempted to keep rates low through quantitative easing, their efforts now seem in vain,' says Kim Rupert, an analyst at forecaster Action Economics.

This increase in yields is pushing up the cost of loans offered to homebuyers and businesses, just at a time when the economic recovery is most fragile. Mortgage lenders in the UK have responded swiftly. Nationwide Building Society hiked its five-year rate from 4.98% to 5.84%. Yorkshire Building Society and state-owned Northern Rock have also increased rates. Ray Boulger, senior technical adviser at mortgage broker John Charcol, warns that any signs of recovery in the housing market risk might be 'snuffed out' by the hike in mortgage rates.