The froth in the stock market's glass

With the notable exception of retail price inflation, most of the economic news seems poor at the moment: growth is weakening, the trade gap is widening, and unemployment is on the rise again. This unholy trinity was seized upon by Labour as evidence of an economic weakness much greater than the Chancellor was letting on. The stock market plainly doesn't agree. Yesterday the FT-SE 100 reached an all-time closing high. Some of this has nothing to do with the economy. Buoyed by takeover fever following the bid for Fisons and the merger of Upjohn and Pharmacia, and uplifted by a rebound on Wall Street, the market is riding a tide of sentiment. But there are also more solid reasons for the revival in the City's spirits.

The slowdown revealed by yesterday's official statistics, together with the encouraging wage and retail price inflation figures last week, has changed the interest-rate story. Until the last few days, the question was whether the Chancellor could keep interest rates at 6.75 per cent. Now the City is looking forward to a cut in rates. The rise in gilts - the September futures contract rose two-thirds of a point on the day - undoubtedly helped the equity market.

The celebration may seem premature, given the real dangers of a more pronounced slowdown in the second half of the year. There is a considerable risk that the UK may repeat the US experience of a sharp inventory correction. The increase in stockbuilding helped to sustain growth in the second quarter; a rundown in the next few months will bring growth down. With a trend of flat investment and disappointing export performance, it doesn't take much to view the glass as half-empty.

But the City's clear preference to see the glass as half-full can equally well be defended. Even if there is a further slowdown in the next few months, this should be followed by a resurgence in growth. The world economy should benefit from the prospective further easing in US and German interest rates. This in turn will lead to increased exports. At the same time, the tightening of fiscal policy will come to an end next year, and the Chancellor can be relied upon to provide a further fillip with tax cuts despite his obvious lack of scope for doing so. For the moment the bulls have it. But the risks of a relapse still look worrying. The London market remains highly vulnerable to a correction on Wall Street, which begins to look all too possible. Froth in technology stocks is generally reliable evidence of an overvalued market.