Hamish McRae: If the world economy continues to grow, we will be pulled along, too

Economic Life: In the UK there may be a case for a further monetary boost, presumably by a another bout of quantitative easing if things slow seriously

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The Independent Online

There has been a huge amount of economic information this week, most of it negative, and always at these times the difficult thing is to distinguish what is really new, what confirms what we already know, and what is simply background noise. Taken together the broad message is that there will be some sort of pause in the developed world's recovery and the issue of course is whether that might slide into something worse.

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Among the significant chunks of policy were the no-change interest rate decisions by the European Central Bank and the Bank of England, and the jobs package of President Obama. Writing ahead of the US move, the only point to be made is that the buzz ahead of the announcement was not especially positive. Be a bit suspicious of that and also the market response today, for these things take a while to settle down and second thoughts are usually better than first ones.

As far as the two European non-moves were concerned, the key new information was the swing in the tone of the ECB statement and in the press conference after the announcement. The ECB has dropped its bias towards tightening policy and its president, Jean-Claude Trichet, acknowledged that Europe does face a serious slowing. It would be quite consistent were the ECB to start reversing its two recent interest rate increases in either October or November.

This was the penultimate meeting with Mr Trichet as the ECB's head before he hands over to Mario Draghi, and some have suggested that this might have some influence on the cut's timing. Actually, it is just common sense to acknowledge that growth throughout the developed world seems to be slowing and this might need a change in policy.

As far as the UK is concerned we have to wait another two weeks for the minutes and the votes but the reality is that there may be a case for further monetary boost, presumably by another bout of quantitative easing if things slow seriously. The danger is that the extra cash would simply create higher prices rather than extra demand so this policy should be seen as an extreme measure, which in an ideal world you would not want to take. But we will see.

Other bits of news on policy included the passing of an austerity package by the Italian senate yesterday and earlier in the week, the capping of the Swiss franc by the Swiss National Bank, plus some shenanigans about the Greek rescue package. The markets are now pricing in more than a 90 per cent probability of a Greek default. Of these various events the Swiss measure was the most dramatic because it took the markets by surprise. But actually to put a ceiling on a currency is a reasonably common act for countries that are flooded by hot money (or in this case funk money) inflows. It is interesting, though, because it reminded everyone that there is some room for manoeuvre for central banks. Action on fiscal policy may be highly constrained but there are options for monetary policy.

Elsewhere the OECD downgraded just about all its growth forecasts, massively so in the case of the US, and warned of the threat of recession here in the UK and elsewhere. But while the OECD's judgement is always worth listening to, I do think here it is telling us what we already know. We know things are slowing; what we don't know is by how much.

To try to catch some feeling for that I have been having a look at the global leading indicator developed by Goldman Sachs. The top graph shows how it has given a fair steer for what might happen to global industrial production, that is of the major developed countries plus the Brics. It turned down somewhat ahead of the collapse in 2008 and turned up ahead of the recovery. As you can see now, it is pointing to a clear dip.

Goldman comments: "It is clearer than ever that the key characteristics of a post-bust recovery... are firmly in place. So the key short-term question will be whether the latest financial disruptions are enough to prompt fresh deterioration in an economy that was already growing slowly, pushing the US, and perhaps Europe, into another recession."

The conclusion is that we don't know yet but the present situation is untenable: things either get better or they get worse. The unknown is the extent to which the present financial strains will transmit through to the real economy, with European sovereign debt and banking pressures particularly grave.

The bottom graph shows one aspect of this: what has been happening to bond yields for Spain and Italy. As you can see yields suddenly shot up in July. They then fell back but that was because the ECB entered the market buying them. More recently the yields have started to creep up again. That does not of itself suggest the ECB intervention has failed but it looks uncomfortable: you cannot go on forever with the ECB buying debt because no one else is prepared to do so. Neither Spain nor Italy are yet in the position of Portugal or Ireland, let along Greece, but there are uncomfortable parallels. The danger is that confidence will slither further and Spanish and Italian banks will find it hard to retain deposits. Commenting yesterday on the position of Italy, Capital Economics noted that there was no doubt that it was "in a very precarious position and that the problems there pose a major threat to the future of the eurozone".

Set alongside the European woes what has been happening in the UK seems mundane but of course were the US and/or Europe go back into recession we would be pulled down too. According to the official figures the UK recovery is lagging a little behind that of the US and Europe and even if you expect as I do that much of this data will be revised upwards the fact remains that the very latest numbers are undoubtedly discouraging. The short answer to the question as to whether this will be a slowdown or a return to recession is that we cannot yet know.

Much depends on Europe. I think we have to assume that the political will to hold the eurozone together is so great that it will prevail for a while. The danger is that those efforts will not only condemn large parts of the continent to prolonged economic stagnation but also drag down even the stronger members.

A final thought: what are share markets saying about this confused backcloth? They signalled grave concerns in July and early August, giving a sort-of early warning. But while they remain deeply concerned they have subsequently recovered somewhat. The general feeling seems to be that they have priced in most of the likely bad news: insofar as you can calculate it, equities seem to be pricing in a mild recession, while the very low bond yields for the US, Germany and the UK, would suggest a decade of very slow growth for the developed world. Why else should anyone buy 10-year bonds that yield significantly less than the current rate of inflation?

I personally find this implausible. The aftermath of the fiscal and banking crises will be a drag on growth of course but the emerging world will continue to grow swiftly. I think what we are seeing now is a reaction to the inflated expectations for the US recovery and to the incompetence of the politicians who constructed the euro. But if the world economy as a whole continues to grow at a decent clip even the weaker developed countries will be pulled along, too.