It was a week of financial drama, with
commonsense eventually prevailing as the US Congress approved the $700bn bank
bailout. Even Europe started to bicker internally about its own $420bn “bank
rescue fund”, following the US lead.
It was also a week in which a deep synchronized
global recession finally took hold.
Thus we swap the fat for the fire.
America, Europe and Japan simultaneously entered
recession recently. Doing so together rather than serially and considering the
severe financial contraction underway, the global recession now unfolding won’t
be short or shallow.
Instead it could be sharp, deep and elongated.
There is risk of three quarters of recession in
all three regions, with 3Q2008 through 1Q2009 most at risk, duration possibly
further extended through 2009 in some areas.
Instigators include housing implosions eroding
household wealth and access to credit while inducing caution. Exploding
commodity prices through mid-2008 eroded real purchasing power. The main
problem is financial contraction, global banks massively deleveraging,
impairing new lending to businesses and households in America and Europe,
severely depressing confidence.
The midwives facilitating recession are cutbacks
in household and business spending, with global business responding defensively
to weakening consumer sales, also preserving cash flow while facing credit
rationing.
Fixed investment outlays faltered, rising
inventories were pared, labour laid off and working hours shortened, US
non-farm payrolls so far in 2008 declining by 760 000.
This gathering gloom is now triggering global
policy mobilization to address the growth falloff, arrest the slide, achieve a
bottoming out and start cyclical recovery. It will be an effort of many policy
instruments waged by many countries together.
Fiscal stabilizers will expand automatically as
budgets deteriorate supportively. Monetary policy is also turning supportive.
The BoE is expected to cut rates this week,
ultimately lowering UK rates as low as 3% next year. This should weaken
Sterling, bolstering growth.
US financial events have induced severe
rationing of new credit. Treasury will use its new powers to try and unclog the
banking system, while the Fed will further expand its provision of liquidity.
It may not be enough.
As US real activity slides deeper into
recession, fear about inflation is being replaced with growing concern about
growth.
To make the bank bailout more palatable to
lawgivers, Congress tacked on another fiscal stimulation package of tax cuts
worth $150bn. It won’t stop the slide.
The Fed already lowered US interest rates to 2%
earlier this year, leaving little scope to do more. Still, bailout and
liquidity provisioning should assist in settling sentiment, reducing record
bank spreads, lowering the high effective interest rates.
Also, the Fed seems ready to cut by 0.5% later
this month to 1.5%, with another 0.5% cut possible in early 2009, Fed funds
thus revisiting 1%.
Such rate cutting may be partly negated by a
stronger Dollar, reinforced by global banking funding needs.
Furthermore, in 2001 US households were able to
support recovery through massive borrowing. This time there won’t be a
consumer-of-last-resort. Instead, the US government balance sheet needs to do
the heavy lifting. Everything suggests it will be pressed into action,
supporting the banking sector but also providing fiscal tax breaks, welfare
support and infrastructure spending.
In Europe, the ECB last week signaled
capitulation, only very shortly after still raising interest rates to 4.25%
last June. But then commodity prices broke and financial unraveling came
quickly.
European activity levels have been falling since
2Q2008, general recession is now a reality, inflation is falling, second-round
effects are also going into remission and inflation could collapse next year.
This should trigger the ECB into rate-cutting
shortly, going as low as 2.75% next year. A weaker Euro will also be
supportive.
All these actions should assist in maintaining
income, arrest credit impairment, restore purchasing power, provide incentive
and boost confidence.
With inventories and labour forces eventually
pared down, and consumption starting recovery, business could become
expansionary again. Gradual recovery is expected only from later in 2009.
Emerging markets will see export growth
curtailed. Efforts will be made to stimulate internal domestic demand,
especially consumption through easier credit and fiscal action and through
intensified infrastructure spending. Weaker currencies will also be supportive.
South Africa is being impacted by these global
events. Commodity export prices are sliding. Export volumes may disappoint,
undercutting growth.
Automatic cyclical stabilizers have kicked in,
with budget surplus disappearing and the Rand weaker in 2008.
With our inflation also having crested and
giving way next year, reinforced by oil below $90, and second-round effects
also likely moderating, the SARB could modestly follow global central bank
example and also cut rates.
It would not be inappropriate to start the new
monetary easing this week. But SARB may well decide to be in the global
caboose, preferring the BoE, Fed and ECB to be clearly leading. This suggests
the December MPC meeting for our first 0.5% cut.
Prime should ease from 15.5% now to 13% by
mid-2009.
Cees Bruggemans is Chief Economist of First National Bank
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