Global economic forecasts for 2009 are substantially negative, and the popular wisdom is that we are now faced by a recession that is likely to prove longer and deeper than previous major downturns. But Richard Jeffrey, chief investment officer atCazenove Capital Management, believes another outcome is possible.
“Just possibly, the credit crunch is causing timescales to become compressed, leading to steeper declines in activity. This encourages the view that the recession will be worse than it really will be.
"The banking crisis has brought forward some developments that would normally have taken place over a longer recessionary period. The further we get from the crisis, the greater will be the influence on activity of monetary easing. It is unwise to assume that because the major economic cycles have fallen in sync they will stay that way,” he said in a statement.
“This not likely to be the case as the synchronicity was caused by a near-cataclysmic event powerful enough to dominate other weaker trends. As the impact of that event diminishes, economies will begin to follow different paths as they find their way out of recession. Those paths will be influenced by policy decisions that have been taken not just over the past few months, but during the previous few years,” he said.
On monetary policy, Mr Jeffrey sees an obvious contrast between
interest rates in the
UK. Both central banks followed policy courses that were inappropriate for periods of strong growth. But the swings in interest rates were much greater in the
US. And in the
US, the period of excessively low interest rates was more prolonged.
This, plus ‘social lending’ policies, caused large numbers of households to take on debt that proved unaffordable. The period of monetary tightening that followed (lasting from mid-2004 to mid-2007) put large numbers of households into severe financial stress. Thus, although the easing started in September 2007, it failed to prevent a rising level of defaults amongst ‘sub-prime’ borrowers.
The proportion of delinquent
US mortgages rose from 4.8 per cent in the first quarter of 2007 to 7.9 per cent in the final quarter of last year. In the
UK, the tightening started later, with a smaller rise in interest rates and shorter timespan. As a result, the number of households that have found themselves in a position of severe stress has been much smaller.
Mr Jeffrey believes alleviation of the financial pressure came through sufficiently early to ensure that households that might have found themselves in risk of default, had the higher mortgage interest rate persisted, suddenly found themselves in exactly the opposite situation.
The unprecedented reductions in interest rates seen over the past six months have given many households with mortgages an equally unprecedented cash-flow windfall. Mr Jeffrey believes it is worth emphasising that the monetary easing has come through at a much earlier stage of the downturn in the economic cycle than is normal.
The normal lag between interest rate changes and their impact on demand is between nine and twelve months. The implication is that in the second half of this year, improvement in household cash flows should begin to impact on demand.
This does not mean that there will not be continuing negative influences. However, Mr Jeffrey thinks that the extent of the monetary easing will begin to have a more powerful effect on attitudes later this year.
One very clear threat created by the banking crisis is the restricted availability of credit. While there is little that households can do to protect themselves from this, companies can take a number of actions. Most obviously, they can cut inventories, reduce capital spending, lower advertising and marketing budgets, reduce employment and cut dividends.
The threat of the crisis caused companies to take extremely rapid action designed to conserve cash on almost all fronts. In turn, this caused a steep downturn in activity. While we cannot yet be certain, Mr Jeffrey warns, of the following logic, it may well be the case that this has caused developments that would normally take place over a longer period to compress.
This steeper than-normal decline in industrial activity has given the impression that the economy is set for a deeper and possibly more protracted downturn than normal. In actual fact, the threat of a credit crunch may actually have caused companies to take action that now leaves them in a better condition to cope with the next stage of recession than usual.
The very negative inventory and investment cycles that are currently evident could mean that near-term activity indicators actually undershoot expectations. In turn, this could result in the recorded peak-to-trough decline in activity being greater than the 4.3 per cent recorded in the 1980s recession.
But, according to Cazenove, this will be the result of the acceleration of cuts in spending that might normally have taken place over a longer period. The risk is, of course, that this causes further negative feedback into an already fragile economic system, with the result being that there is another lurch down in activity.
Currently, the firm thinks that activity in the first half of the year will deteriorate more than anticipated, but that trends in the second half, driven by household spending, are materially better than are being forecast. This could encompass a return to a positive growth trend before the year-end.
None of this changes Cazenove’s expectation that the necessary
deleveraging that must happen in the
UK will place a long-term burden on the economy that will likely be reflected in sub-trend growth for an extended period.
Following the introduction of quantitative monetary easing, the firm believes that there is a risk that weak growth will be accompanied by rising inflation.