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Economic relief "only temporary"

Economic relief

The current strength of some major western economies might not last amid worrying signs of a slowdown in the Chinese economy and the continued dampening pressure of high oil prices.

In Germany, the Ifo index of the business climate hit a seven-month high this week, and next week's US figures are expected to show good rises in employment and manufacturing output – an upturn which has caused smaller US stocks to hit all-time highs. But Michala Marcussen at Societe Generale says this is "only a temporary bright spell".

One problem is that China's economy is slowing down – the latest purchasing managers' survey found that manufacturing output there is falling at its fastest rate for four months. This matters for the euro area and US because it will reduce export demand. Ms Marcussen points out that falls in China's purchasing managers' indices tend to lead to falls in the corresponding euro area and US indices within two or three months.

A further problem is high oil prices – the price of Brent crude has risen by $15 per barrel since mid-January to close to its highest level since July 2008. Economists at Morgan Stanley estimate that each $10pb rise in the oil price reduces US and euro area GDP by around a quarter of a percentage point. Partly reflecting higher petrol prices, figures this week showed a fall in German consumer confidence.

Federal Reserve chairman Ben Bernanke added a third concern this week when he warned that "we cannot yet be sure that the recent pace of improvement in the labor market will be sustained". This poses the danger that the virtuous circle of increased jobs leading to increased consumer spending and hence more jobs might soon end. Households seem to share Mr Bernanke's fears – the Conference Board reported a drop in consumer confidence this week.

All this matters for investors because slower economic growth usually reduces investors' appetite for risk and so depresses share prices. Worse still, the same lower appetite for risk might also dampen banks' desire to hold riskier, higher-yielding government bonds, which in turn would remind investors that the euro area's debt problem has not been permanently solved. "The debt crisis is not over yet," warns Ms Marcussen.

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By Chris Dillow,
28 March 2012

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Chris Dillow

Chris spent eight years as an economist with one of Japan's largest banks. Here, he provides insightful commentary on the latest economic news and data, along with thought-provoking articles about investor behaviour.

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