How quickly and strongly will the economy bounce back from the downturn?
The answer to this question will determine the fate of many businesses this year and hinges on the relative strength of two opposing forces. The positive force is the major relaxation in economic policy we have seen in the US and Europe over the last year. Government spending and tax policies have also been used to boost economic activity in the US – and to a lesser extent in the UK.
Interest rates at historically low levels on both sides of the Atlantic should encourage consumers to spend rather than save and provide a lift to business confidence. However, offsetting the positive impact of this policy stimulus is the momentum of the economic downturn. Companies facing difficult economic conditions cut back on their purchases, jobs and investment.
This transmits the downturn through to other firms and to consumer spending – as job losses hit confidence.
Through its effect on international trade and investment are affected, the economic downturn also crosses national borders. In a globalised world economy it is much easier for an economic downturn in one region/country to spread through the rest of the world.
In the second half of last year, this momentum effect was clearly in the ascendant. The US and Japan lurched into recession and the European economy slowed sharply. However, as we move into the New Year, the economic signals are becoming more mixed as the boost provided by low interest rates begins to counter the negative momentum of the economic downturn.
We see this tug of war at play in the latest economic statistics for the UK. Retail performance over the Christmas period was mixed. While individual retailers issued encouraging trading reports, the latest figures from the National Statistics Office in January 2002 revealed that December 2001 retail sales were 0.3% lower than the previous month. Job losses continue to mount in manufacturing industry and unemployment is rising.
A weak world economy means exporters and other activities dependent on trade (for example, business travel) are still having a difficult time.
A similar mixed bag is apparent in the rest of Europe. In the second half of last year, Germany was the weakest of the major European economies and appeared to be on the brink of recession. However, Germany has recently seen some positive signals on factory orders and retail sales. In France, meanwhile, business confidence is rising, while across the euro area as a whole, consumer sentiment has lately staged a recovery.
But the US is being watched most closely for signals of recovery. Stock markets are delivering a positive signal, with the Dow Jones index up by around a quarter on its lows last Autumn. But the news from the real economy is more downbeat. Unemployment continues to rise while factory output is still falling. During 2001, the US suffered its biggest fall in industrial output since 1982, with the strong dollar compounding the difficulties created by weak domestic demand. (This is the opposite of the situation in Europe, where industrialists have been benefiting from the weakness of the euro.)
As in the UK and Europe, it is the consumer side of the economy which is holding up best in the US – reflecting the support provided by low interest rates. Retail spending and the housing market appear to be recovering and consumer confidence picked up in December. But US consumers entered the downturn heavily exposed to high debt. This may make it harder for them to sustain higher spending in the face of rising unemployment and weak business confidence.
This mixed picture of economic indicators in the US and Europe is symptomatic of economies that are close to a turning point, and is consistent with the view that we should expect recovery to emerge over the course of this year. However, we should not underestimate the negative momentum from last year’s sharp downturn in the global economy, which was the most severe for two decades. This creates a formidable headwind to counter the stimulus being provided by low interest rates.
Overall then, we should be cautious about the pace and timing of the global economic recovery. The second half of this year still looks to be the most likely for things to improve – even if there are more encouraging signs emerging as we move through the first half.
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