ANALYSIS: Markets face a long haul on road to recovery

By Andrew McCathie Oct 9, 2008, 16:08 GMT

Berlin - Despite a brittle calm emerging in global share trading Thursday, the world financial system is facing a long haul in its battle to restore confidence.

'There are no quick fix for the problems,' said Rainer Guntermann, senior economist with the investment house Dresdner Kleinwort. 'It will take some time to restore confidence,' he said.

After days of panic share selling, Thursday's modest recovery in stocks allowed market operatives and economists to begin picking their way through the debris left by the latest financial firestorm to hit world markets.

But with the financial crisis unleashed by the surge in defaults in risky subprime US mortgages now in its 14 month, the fears are growing about the impact the current upheaval will have on the world economy.

'We are in for a rough ride for the economy,' said Kenneth Wattret from BNP Paribas. 'We still have a lot of bad news to come.'

'The question is not whether we face a recession, but how deep the recession will be,' Wattret said.

Forecasts of key national economies emerging relatively unscathed from the global credit crunch set off by the subprime mortgage affair now appear overly optimistic in the face of this week's plunge in shares.

The International Monetary Fund this week slashed its global growth projection to 3.9 per cent for this year to 3.0 per cent, which would be the lowest level in six years. The IMF considers world economic growth under 3.0 per cent to represent a recession.

Indeed, it has been worries about the economic spillover from the global credit squeeze that has helped to spark the latest round of turmoil in world markets.

Certainly, a sharp fall off in oil and commodity prices has helped to undercut global inflation rates and as a consequence remove the economic threat posed by spiralling consumer prices.

In the case of Europe, the euro's decline from the record high of plus 1.60 dollars it set earlier this year has also helped to ease some of the pressures on Europe's key export machine.

Economists also expect intra-Asia trade to help economies in Asia to continue to turn in comparatively solid growth performances in the coming months.

At the same time, government policymakers and central bankers around the world have demonstrated a clear sense of urgency in facing up to the financial crisis with a series of radical measures aimed at shoring up investor and public confidence.

This has included steps to buy stakes in banks hit by the crisis and to guarantee savings as well as massive financial bail-out packages to pickup some of the toxic assets held by lenders.

On Wednesday, the US Federal Reserve and the European Central Bank spearheaded a world-wide move to deliver a cut in interest rates to help head off the threat posed by a major economic slowdown and shore up confidence in the global financial sector.

Commenting on the ECB's bold 50-basis points cut, the Frankfurt-based bank chief Jean-Claude Trichet urged financial markets to regain a sense of composure.

'Excessive pessimism is ill advised,' Trichet told France 3 television with the ECB also continuing to pump funds into overnight lending to help ease money market tensions.

Dwindling inflation and slumping economic growth are likely to help pave the way for further reductions in interest rates around the world.

But stock markets are also now gearing up for what could be a particularly grim third-quarter corporate reporting season with scope for further losses stemming from subprime assets to emerge in the financial sector.

Moreover, the root cause of the upheaval gripping the world financial system remains with banks still refusing to lend to each other in the wake of the collapse of several prominent banks and bank rescue operations as well as fears about other lenders' exposure to subprime assets.

This in turn threatens to result in a sharp decline in business investment and rising unemployment.

To be sure, Pawel Cymcyk, Warsaw-based analyst believes that the real economic effects of the crisis won't be felt for several years when we'll see a reduction in incomes.

In addition, bank lending and the housing market, which both lie at the heart of the latest financial market upheaval, have in the past taken years to recover from previous shakeouts, as a consequence further dragging down consumer confidence.

This raises the risk that the current market tensions could persist well into the year, which would pose a major danger to global economic growth and raise the prospects of a particularly sharp contraction in the world economy.