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Market comment: Unrealistic expectations cast shadow over G20 summit

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The current recession is much nastier than originally envisaged. In the last
quarter of 2008, GDP shrank at an annualised rate of around 6% in the US, the UK
and the eurozone. In Japan, the economy plummeted at an annualised rate of more
than 12%. Countries with strong export sectors, such as Germany and Japan, have
suffered worse downturns than the US and the UK with their overvalued housing
markets. China is facing huge pressures.

Employment – The first quarter of 2009 has seen a further
sharp deterioration, with unemployment up sharply. US jobs fell by 651,000 in
February, the third straight month with losses exceeding 600,000. Since the
recession began, the US has lost 4.4 million jobs; more than half of these
losses have occurred in the past four months. At 8.1%, US unemployment is at its
highest in more than 25 years.

Rates – The US Fed funds rate has been at almost zero since
December. In the UK, Bank Rate was cut to 0.5% in March, but further cuts are
unlikely. In both the US and the UK, monetary policy has already moved to the
unconventional arena of quantitative measures, with the aim of unblocking credit
markets and increasing money supply.

The US programme is mainly concentrated on supporting the issuance of up to
$1,000bn of new securities backed by consumer loans. The UK plan (an initial
allocation of £75bn, with the option of increasing to £150bn) is even more
aggressive. The Bank of England is purchasing government bonds, an extreme
measure that is nearest to outright money creation. The European Central Bank,
which cut rates to 1.50% in March, is still moving too slowly. But, in the face
of deepening recession, it will reluctantly have to cut rates further and purs
ue quantitative easing.

The G20 summit, by involving China and other emerging powers in key
decisions, will acknowledge new realities in the global balance of power. But
there are genuine divergences between the key players, which will be difficult
to reconcile. Chinese exports plunged 25.7% in February compared with a year
ago, much worse than expected, as the global crisis damages China’s export
sector. If the Chinese react by devaluing their currency, the threat of a trade
war between the US and China would escalate.

There are also worrying tensions between the US, which advocates aggressive
Keynesian stimulus, and a more cautious Europe led by Germany.

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