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Are we there yet?

Exactly when economic recovery will start is the question all but the most
pessimistic are asking.

Fortunately, at the beginning of January, Bank of America’s head of European
economics, Holger Schmieding, produced a “recovery checklist” for the eurozone.
In it he details leading indicators to look out for that should presage the

No single lead indicator is fully reliable, Schmieding says, but taken
together they “can give a rough idea when a recession may finally end”.
Regardless of whether you are more or less optimistic than Bank of America’s
forecasts as to the timing of recovery, the checklist still works by shifting
the timeline for these indicators.

On the checklist
The good news is that the first item in Schmieding’s checklist,
monetary policy, already has a tick beside it. Since the
summer, the European Central Bank has cut real interest rates (adjusted for
inflation) from 2.4% to around 0.7% in December. A further decline to just below
0% is expected by March when the policy rate should hit 1.5% with inflation at
1.7%. Monetary policy usually affects the real economy with a lag of around six
to nine months, but on this occasion the workings of the financial system are
severely impairing the transmission of lower rates to households and businesses.
Schmieding’s assumption is that the impact of looser monetary policy will take
three months longer to have the desired impact.

To judge whether that assumption is valid, Schmieding’s second item,
monetary and financial conditions, has to be watched carefully.
Asset prices such as equities, mortgage rates, bond yields and the exchange rate
are useful pointers, but the simplest one is real M1 money supply (currency and
overnight deposits, adjusted for inflation). This has a lead time ahead of GDP
of nine months and offers “some tentative hope” that the economy could be
growing again by Christmas 2009, though there are distortions caused by savers
moving their money around as they take fright at the state of the banks.

The German ZEW expectations index provides a guide to
investor sentiment: major and sustained changes usually signpost turning points
six months later, so for growth to resume by Christmas you would have to see the
ZEW turn up by April.

Meanwhile, back in the real world rather than financial, Schmieding looks to
the German Ifo business climate index: “Once businesses no
longer believe the situation will be worse in six months’ time than it is at the
moment, the recovery can begin with only a little lag,” Schmieding says. Expect
this index to lead eurozone industrial output by three months.

As with business expectations, industrial orders for
manufactured exports as well as domestic sales of durable goods and machinery
usually lead major shifts in output by around three months. An end to recession
in Q3 with recovery in Q4 would require expectations and orders to be on the up
by May or June.

Finally, the Purchasing Managers’ Indices are the most
reliable indicators, but only give a lead of one or two months. The advantage is
that the indicators are available well before the GDP data. As Schmieding says,
we have a long time to go before we can tick this box – but stay tuned.

* Our recent poll found that 46% of visitors to our website think the UK
economy will hit rock-bottom in 2009 H2 and 24% think it will take until 2010 to
bottom out. See

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