Sugar rush recovery

The global economy is transitioning from recession to recovery. In the next two to three quarters, we may witness a strong growth spurt in many developed countries. Yet, underlying conditions are anything but strong. Behind the rebound are mostly temporary factors. Thus, we expect a relapse into economic weakness in the course of 2010. Consumer price inflation, however, will remain subdued in 2010, meaning that most central banks will wait until the second half of 2010 before starting to normalize rates.

Long-distance runners know the situation. When energy levels run low, having some sugary drinks can help ease the pain and spur the performance - at least for a short while. Yet, once the effects wear off the athlete may feel even worse than before. Based on this metaphor some observers have dubed the current transition from deep recession to recovery a 'sugar rush recovery'. We have some sympathy with this view. After the extremely steep plunge in global trade and manufacturing activity following the Lehman collapse last autumn, the combined effects of super-loose monetary policy and an unprecedented scale of fiscal spending have led to something akin to a "sugar rush recovery". It will last for a few quarters, but it is unlikely to overcome the underlying problems such as the poor state of private household financial situations in many former housing-boom countries.

Thus, after the surprisingly positive second quarter GDP figures, we expect to see two or three quarters of solid growth, which would make the second half of 2009 look like a typical V-shaped recovery. However, beyond this we think that most developed economies will see a return to weak economic growth in the course of next year. Two factors here are of particular importance: firstly, final demand of private households is likely to remain subdued for a long time and secondly, the fiscal and monetary policy stimuli will have to be phased out starting next year.

Where is final demand?

Final demand is driven by business investment and consumer spending. Given record low capacity utilisation rates in manufacturing, rising vacancy rates in commercial real estate and still very tight credit conditions we think that a meaningful pickup in investment spending is unlikely next year. Likewise, consumers face considerable headwinds. Unemployment rates will continue to rise next year, the disinflationary trend that boosted spending power in 2009 will be reversed, credit conditions remain tight and many households still feel the effects of the drop in global equity and house prices. Above all, however, many households have to pay down debt and rebuild their savings.

Policy to tip the scales

Governments responded to the crisis with the biggest fiscal spending programs in peace-time history. Public deficit levels have reached unsustainable heights in many developed countries. Measures to consoliddate the public finances will most likely be a significant burden to economic growth in coming years.

An even more delicate task is ahead for central banks, which have to prepare the exit from their super-loose and unorthodox monetary policy stance. While the Fed will probably primarily look for signs of labor market stabilization, the European Central Bank is much more focused on longer-term inflation expectations. For now core-measures of inflation (ie inflation excluding volatile energy components) are likely to trend lower until about mid next year, which may even fuel renewed deflation scares. However, after that we expect core inflation to increase again, which will ultimately prompt central banks to start normalizing their monetary policy.