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Salutary retreat

10 April 2012 By Ian Campbell

Markets are wobbling on renewed fears about global growth. Rising yields on Italian and Spanish bonds add to the alarm. And it would be wrong to assume that central bankers will ride to markets’ rescue this time – because oil prices and inflation are part of the global gloom.

Risk assets face a second-quarter correction as central banks – rightly – hold back on further stimulus. Many investors assume that central banks will help because falling stock prices are bad for consumer confidence and growth. But rising oil prices and inflation are also bad for growth. And central bankers may be realising that excess monetary stimulus is behind soaring global oil prices.

“Current conditions do not warrant further accommodation,” said Charles Plosser, the admittedly hawkish president of the Philadelphia Fed, at the end of last month. His fears are shared by other Fed governors. Yet the real risks go much deeper. With ultra-loose money policies the central banks are not just facilitating the spread of inflation, they are creating it at source – via commodity prices. Andrew Sentance, recently of the Bank of England’s monetary policy committee, warned in March that central banks need to rethink, and that further money loosening could recreate the inflation of the 1970s.

Rising Spanish and Italian bond yields and weak euro-zone growth are a further worry for markets. But the European Central Bank, having controversially supplied a fresh trillion euros to banks in what may prove to be a short-term palliative, is ill-placed to intervene again.

Global investors must therefore weigh an ugly mix of risks: the possibility of renewed, intense, euro-zone crisis; middling global growth; and oil prices compatible with recession. And yet U.S. equities have just enjoyed their best first quarter in 14 years after a strong run-up in global equities since 2009. Something has to give.

The likelihood is that stocks and commodities will take the strain. And for global growth that outcome would be positive. A drop of at least $20 to $30 in the global oil price is needed to smooth the path of global recovery. What would be bad for financial markets would be good for ordinary consumers, growth and jobs.


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