• Silver lining. This week brought a spark of hope after economists were forced to constantly revise downward their forecasts after economic numbers fell like a stone. Some important economic barometers now turned north – albeit from extremely low levels (cf. chart).

  • Hope. It was, however, only the forward-looking indicators that regained some traction. And the improvements still have to be confirmed in the coming months before the all-clear can be sounded. But even then, this would only correspond to a stabilization of the global economy in the second half of this year.

  • Recession. The coincident indicators, in contrast, are still in a free fall, not to mention the lagging indicators such as employment. The current quarter will, therefore, most probably be worse than the last. This holds true at least for the US, particularly as inventories still have to be run down substantially. And the fallout from the credit crunch will presumably continue further (pages 7-9 and 10-12).

  • Risk. The recession will, therefore, persist until at least the summer, before the global economy can stabilize. There was, however, the first flicker of light at the end of the tunnel. It should not, however, result in monetary and fiscal policymakers relaxing their efforts. Trichet’s press conference yesterday gives hope that this will not happen.

  • Further topics:

    – Weekly Comment: If you wish for a recovery ... (page 2).

    – ECB: Zero Interest Rate Policy no longer taboo (page 4).

    – German construction: Stimulus package to prevent the worst (p. 13).

    – Data outlook: GDP shrank dramatically in Q4 2008 in EMU countries; US retail sales continue to plummet (page 16).

    – Market outlook: EUR remains weak, bonds sideways (p. 22).


If you wish for a recovery …

Recent data have brought a glimmer of hope that the recession may be bottoming out. The temptation to believe the worst is over is strong, but should be resisted, as the underlying recessionary forces are still too powerful and governments are still struggling to get the financial sector back on its feet. It will take at least a few more months before we can say with any degree of confidence that the recovery is at hand. The latest data simply confirm that the greatest risk we face is not a deeper recession, but a longer one. The Bank of England is well aware of this, and, for that reason, cut the repo rate another 50 bp yesterday, and will soon launch direct purchase of corporate bonds and commercial paper. The latest data will be an important injection of confidence for the more cautious members of the ECB, but the Governing Council should resist the temptation to postpone further action, and clarify its view on the desirability and feasibility of Quantitative Easing. If you wish for a recovery, prepare for a depression.

We all want to believe that the worst will soon be over, and some of the latest data provide an almost irresistible temptation for hope. We had entered 2009 braced for the worst year on the post-war record, but it only took a few better than expected statistics to show how desperately eager we are to glimpse the light at the end of the tunnel. January PMIs in the eurozone showed some tentative signs of bottoming out (cf. chart). The manufacturing index was confirmed to have risen from the previous month, and the same was true the services index, which allows for an uptick in the composite PMI. Even more importantly, a significant reduction in inventories points to a somewhat improved outlook for production in the months ahead.

This slightly more upbeat tone was echoed in some of the EEMEA countries, particularly Poland and Russia. The eurozone EC economic sentiment index in January seemed to break its precipitous drop of the previous three months, falling by just over one point after losing 20 points in Q4 2008. The picture was confirmed across most countries in the region, with Italian manufacturing confidence also slowing its pace of decline.

Across the Atlantic, the ISM indices showed a visible rebound in January, beating expectations after five consecutive months of steep fall (cf. chart). Even in the UK, the manufacturing PMI staged a surprising rebound, confounding expectations of a new record low.

I find these tentative signs of stabilization neither too surprising nor particularly reassuring: after the dizzying deterioration experienced in Q4, where virtually every activity indicator fell at an unprecedented speed, an easing in the pace of the contraction was becoming increasingly likely. Forecasters in financial institutions and research institutes will now have a chance to take a deep breath and a look more closely at the data, after having been forced to revise their projections lower almost every two weeks for the last three months.

The underlying recessionary forces, however, are still extremely powerful on both sides of the Atlantic: (1) confidence indicators remain at extremely low levels; (2) unemployment will continue to rise probably for most of the year; and, last but not least (3) the risk of a credit crunch remains extremely serious as governments still struggle to restore confidence and sound balance sheets in the banking sector. The latest data therefore confirm my impression that the greatest risk we face is a longer recession, not a deeper one. But there is still enormous uncertainty on the timing and speed of the recovery. Against this background, the three main central banks are still in the frontline: the Bank of England and the ECB were in the spotlight this week, and the Fed meanwhile is engaged in yet another tug of war with the markets on the level of long-term yields.

The BoE cut, as was widely expected, its repo rate by another 50 bp, bringing the policy rate to 1.0%, but in the meanwhile it has already shifted the focus to quantitative easing measures targeted to improving the flow of credit to the corporate sector. As agreed with the Treasury, the Bank will start by purchasing corporate bonds and commercial paper, and consider buying syndicated loans and asset backed securities, and will monitor the impact on both the availability and the cost of credit for UK companies. The BoE is therefore joining the Fed in de facto sidestepping the banking system to channel credit directly to the real economy and prevent a worsening of the credit crunch.

The ECB also seems to have become more open to the idea of quantitative easing, and possibly driving policy rates close to zero (cf. Research Note on yesterday’s ECB meeting). We believe further action is needed, and needed soon, because the risk of a prolonged slump in activity is high, and a loss of momentum in the policy effort is the last thing the eurozone needs.