Drowning, or just taking a dip?

MARKETS: Analysts weigh up reactions to Wall Street's tumble and what might have caused it
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The Independent Online
When Wall Street has a fit of nerves, results are dramatic. The Dow Jones Average had its biggest fall for nearly six months on Thursday with an 83-point dive and shed 20 points yesterday before recouping the loss.

There are two explanations. One is that the economy is slowing down so sharply that there will be a recession, with lower corporate profits than investors had expected. The other is that growth is about to bounce back after a brief pause, fanning the embers of inflation and making the Federal Reserve raise interest rates.

On Tuesday, we will know whether the chief pilot of the US economy, Fed chairman Alan Greenspan, still believes his craft is coming in for a soft landing. The Federal Open Market Committee will meet to decide whether interest rates need another nudge.

Most Wall Street analysts do not expect the Fed to change interest rates next week. Federal Reserve Board members have recently been making cautiously optimistic noises about commander Greenspan's skill in steering the economy.

His vice-chairman, Alan Blinder said this week that it will require a bit of luck, but the slowdown evident this quarter should give way to "more normal" growth later in the year.There is no sign of inflationary momentum, he thinks.

Economic expansion has clearly come off the boil in the early part of this year. From an annualised rate of 5.1 per cent at the end of last year, GDP growth slipped to 2.8 per cent in the first quarter of this year.

Recent figures have hinted at even flatter growth in April. First came a shock fall in employment, down 9,000 following a rise of 177,000 in March. Retail sales fell, despite widespread Easter promotions.

An anaemic increase in housebuilding starts and a drop in sales of existing homes suggested the housing market was flat or worse. Industrial output dipped 0.4 per cent, dominated by falling car production.

Figures like these lie behind the weaker profits growth scenario. Thursday's trade figures, showing a surge in America's deficit with Japan, were the catalyst that crystallised fears of recession.

Other analysts think the recent figures are signs of a pause.David Bloom, US economist at James Capel, says: "The big R is not just round the corner." The slower economic performance now is thought to be due to over-production.

Until there is more conclusive evidence, the Fed would amaze commentators if it raised interest rates next week. Later in the year, perhaps, the Federal Funds rate could have to rise for the eighth time, if growth does rebound. Yet some economists argue that danger could be averted if America's politicians make progress on cutting the huge government budget deficit.

Both houses of Congress have recently put forward plans to bring the $200bn Federal budget deficit into balance by 2002 by cutting $1-1.4 trillion from spending plans.

There is still hope that Mr Greenspan will bring the economy in for that soft landing - especially if half of Wall Street thinks the US is plunging into recession while the other half sees soaraway growth.