Outlook: Equity prices

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The Independent Online
MORE AND MORE curious grows Alan Greenspan's decision last week to cut US interest rates - the third such cut in two months. According to revised figures just released, the American economy grew at a stonking 3.9 per cent in the third quarter of this year, fed by a consumption binge of almost unprecedented proportions. Inflation may be in abeyance, but it is surely the case that with US economic growth now beginning to show all the characteristics of a tiger economy, rather than a standard, low growth OECD laggard, the US should be increasing interest rates, not lowering them.

What's more, US stock markets have recovered to a level which Mr Greenspan must find alarming in the extreme. In doing so, moreover, they have been underpinned by the prospect of ever cheaper money, for there is no other reason why they should be back at levels last seen in mid July. US corporate earnings are falling, despite the boom economy, and while things might still seem rosy in the US, they look pretty horrendous elsewhere.

Take the UK. Our trade deficit in goods is now at its highest level in nominal terms since records began 300 years ago. Thankfully, the UK is still running a healthy pounds 1 billion trade surplus on services, but this is not enough to outweigh the now yawning gap in goods. The dire economic situation in the Far East has hit export demand, and has led to a flood of cheap imports. Perhaps more importantly, the strong pound has finally begun to undermine British competitiveness, making UK firms seem expensive against overseas rivals.

The near-term outlook for UK trade is little better. Although the recent weakening of sterling will provide some respite, it takes time for changes in the exchange rate to feed through into the real economy. It is only now that we are seeing the full consequences of the pound's strength during 1997 and early 1998. Recent cuts in interest rates will also help. But again, it can take as long as two years before lower interest rates really make a difference.

All this suggests the outlook for 2000 and beyond may not be too bad. In 1999, on the other hand, the UK economy looks like it's in for an exceedingly rough ride. Back in the US, the economy and the stock market are booming, but corporate earnings are falling - all this against a world economy which is slowing dramatically. The picture is a deeply confusing one. In such circumstances it is no wonder many are beginning to question whether Mr Greenspan has got his policy stance right. Could this be a repeat of 1987, when central bankers over reacted to the stock market crash, thereby accentuating the latter stages of the boom and deepening the subsequent recession?

It would be disingenuous of this column, which along with many other commentators, urged Mr Greenspan and other central bankers to make sharp cuts in interest in response to the global turmoil, now to turn round and say he's got it all wrong. On the other hand few could have predicted the scale and speed of the recovery in world equity markets. If Mr Greenspan thought stock markets irrationally exuberant two years ago, when he first coined the phrase, what on earth does he make of them now?