Markets fall, but no recession yet

STOCK markets do not always get it right. That is one of the most obvious lessons from the tech bubble of the 1990s. But it would take a brave person to dismiss the warning signals presented by the latest slide in shares.

While it is often said that equities have predicted seven of the last three recessions, the sheer scale of the current bear market and the accompanying re-evaluation of risk by investors provides a disturbing backdrop for the world economy. Nowhere is this more visible than in the United States where speculation surrounding a slide back into recession, the so-called 'double-dip', has heightened in recent weeks.

Already there are signs that companies are putting investment plans on hold in the face of financial market turmoil. Shopping malls remain busy for the time being, but there are increasing fears that American consumers could throw in the towel as they respond to a massive reduction in their wealth.

Potentially even more disturbing is the lack of pricing power for many businesses. This, if nothing else, makes the current expectations for double-digit growth in earnings per share look fanciful. Any shortfall could trigger another round of corporate restructuring as firms seek other ways to repair their margins.

It is anybody's guess how well US households will cope with a further rise in unemployment, as they nurse their wounds from the share collapse. It is not surprising that there is renewed talk that the Federal Reserve will provide a further boost for the economy by lowering its key interest rate, possibly as early as tomorrow. Whether another quarter, half or even three-quarters of a point cut will make much difference, when the Fed funds rate is already down at 1.75%, is questionable.

It is conceivable that, at some point, the authorities may need to go further and consider more direct means, such as boosting the money supply, to help liquidity (and, hopefully, confidence). The Fed has certainly made clear that it is willing to take a few risks (with inflation) to avoid following in the footsteps of Japan.

Possibly even more significant could be the belated conversion of President Bush to full-blooded Keynesianism. With almost perfect timing, he has launched the largest defence spending programme in almost two decades. The benefits of this may take a little time to feed through but they should, ultimately, have a meaningful impact on demand. None of this may be sufficient to prevent another quarter or two of flat or even negative growth in the US.

Moreover, it may well prove right to have only limited expectations for the American economy over the next couple of years as the problems from excess capacity and the misallocation of corporate resources during the 1990s are addressed.

What impact will a period of slower US growth have on the UK? There is no getting away from the fact that events in America have a major bearing on economic developments this side of the Atlantic. Yet it has been clear over the past year that the impact is not an overwhelming one.

Growth may have briefly stagnated in the UK, as the GDP figures suggest. But with employment still at a record level, it would be stretching credulity to suggest that we have come anywhere near recession. The overhang of productive capacity is rather more modest in Britain, consumers are still enjoying healthy gains in real incomes and, fortunately, the MPC still has plenty of scope to cut interest rates. Significantly, even the Committee's arch hawk Mervyn King is now hinting at a renewed willingness to ease policy.

The huge increases in Government spending should also help ensure that recession remains little more than a risk over the next 12 months. The exception to this is the hard-pressed manufacturing sector. Once again, it looks likely to be in the firing line should the global economy continue to deteriorate.