The financial markets remain torn by conflicting fears of an immediate slump,
unsustainable debt burden and future inflation. Deflation is a short-term risk.
In 2009, the US will experience its first full-year fall in consumer prices for
more than 50 years.
But the markets are also worried that massive injections of stimulus and
increased borrowing will eventually unleash higher inflation. The pervasive mood
is one of gloom, driven by fears of deepening recession. As in Japan’s “lost
decade”, a deep banking crisis remains the critical obstacle.
US jobs fell by almost 600,000 in January, the biggest fall in 34 years and the
third month in a row of declines exceeding half a million. The jobless rate rose
to its highest level since 1992. US job losses since the beginning of the
current recession now total 3.6 million and are set to worsen in 2009.
House prices are falling at their steepest pace on record. The 1% rise in US
January retail sales was a surprising piece of good news, but the markets have
shrugged it off in the face of an avalanche of poor figures.
Europe’s downturn is steeper than in the US. Eurozone GDP plunged 1.5% in the
fourth quarter of 2008, the same decline as in the UK, but more than the 1% fall
in the US.
Germany, with its heavy exports dependence, has been particularly badly hit
by the global recession. Its economy dropped 2.1%, the steepest fall since
reunification in 1990.
The European Central Bank persists with its obstinate stance and has kept its
key rate at 2%. While rate cuts are now almost certain, policy remains too
tight. In the UK, Bank Rate was cut to 1% and further cuts to 0.5% are likely.
But sterling’s weakness exposes the UK to serious risks.
In the US, the Federal Reserve says it will keep its key rate at almost zero
for a considerable time. But policy must now focus on quantitative and credit
easing, which requires close cooperation between the Fed and the Treasury. The
Fed has led the way with aggressive interest rate cuts and is more determined
than Europe to boost the money supply by purchasing government bonds.
But negative reaction to the Obama banking package is because of US
ideological reluctance to take measures that entail any bank nationalisation. To
avoid negative global consequences, a more flexible US line is needed that
absorbs the lessons of Japan. Without sorting out the banks, there will be no
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