Global recovery could yet run out of steam

Economics: Despite the optimistic consensus, oil-price volatility and steep US deficits make the future hard to predict writes Cliff Taylor

Today the focus moves to monthly US employment figures. And the world economic recovery will be declared a complete success - or in mortal danger - depending on the latest reading from the US jobs market. The figures will be presented by market analysts and the media as the definitive reading from the pulse of the world's biggest economy - until the next batch of data.

The analysts are always looking for something to churn the markets, of course, and us media types are never slow to turn a drama into crisis. In the cut and thrust of daily data and commentary, it is difficult to keep a focus on the big picture.

One recent report said US factory orders rose 0.7 per cent in June, compared with a "revised" 0.4 per cent in May that was initially reported as a 0.3 per cent fall. You have to read it a few times - or at least I did. The "revising" seems a particularly cunning ploy, where an "estimate" is published first, to be followed some weeks later by a final figure.

However, something of a pattern has emerged of late of figures being a bit worse than expected; take this week's US consumer spending data, for example, which showed a 0.7 per cent drop in June. With oil prices on the rise and interest rates on the way up, is there a danger that the recovery will run out of steam?

The international recovery has been US-driven, so analysis must start there. There is no doubt that the US economy hit a soft patch in June. The consumer figures were the clearest signal, with car sales particularly weak, but other data paint a similar picture. Higher oil prices certainly played a part, as did a jobs market that was lacklustre.

The conventional wisdom, which goes as high as Federal Reserve chairman Alan Greenspan, is that, despite this, the recovery remains on track. US growth was a disappointing 3 per cent on an annualised basis in the second quarter, but slack car sales take much of the blame. A pick-up in business investment will feed through to a better jobs market in the second half of the year and consumer spending will follow suit. Or so the theory goes. Analysts at Morgan Stanley, for example, believe there is "pent-up" demand for 1.8 million jobs following the huge cutbacks of recent years.

If the US recovery does regain momentum, the rest of the world will benefit. There are some positive signals in the euro zone, although here the recovery is well behind the US and unemployment continues to rise in the big economies.

Analysts believe growth in the euro zone may be running at a rate of somewhere over 2 per cent at the moment. This is driven by higher exports, much of them to the US.

Again, there are questions about the sustainability of this growth. What is required is that higher output feeds into higher employment. In turn, this would boost domestic demand in the big euro-zone economies by increasing consumer demand, which so far has been lacklustre at best. However, this has yet to happen, with another rise in German unemployment reported this week, bringing the jobless rate in the euro zone's biggest economy to 10.6 per cent.

So will it all be OK? The indications are that some nervous months lie ahead. Oil prices are the most obvious danger, hitting all-time highs this week with implications for consumer spending and business investment in the big oil-consuming economies.

The back-of-the-envelope calculation is that each sustained $10 rise in oil prices knocks 0.5 of a percentage points off economic growth in the industrialised world.

The key word here is "sustained". Oil prices could ease back in the months ahead, in which case the impact of the recent spike will be limited. That said, there are plenty of analysts who believe it could rise to $50 or more, which would cause some serious revisions to growth forecasts.

As ever, the oil market is less than transparent, but it does appear that supply is particularly tight, stocks are on the low side and demand remains strong. The expected slowdown in Chinese demand, for example, has still to emerge. Meanwhile, the terrorist threat continues to hang over the market.

Looking beyond the next few months, the key question is what could provide momentum to the world economy moving into next year.

This is where things start to look a little cloudy. The huge fiscal stimulus that has supported the US economy will have run out of steam and there may well be post-election belt-tightening, much like the cutbacks - sorry, "adjustments to the rate of growth" - experienced here over the past couple of years.

As the fiscal stimulus is removed, so too will be the monetary one. The Fed is already moving rates upwards and whatever machinations it goes through to avoid an increase in the run-up to the November poll, borrowing costs will be heading upwards moving into next year.

Meanwhile, the euro-zone economy looks set to grow next year by 2.5 per cent at best, and even in the UK higher rates mean growth looks set to ease.

Perhaps, by then, the US economy will have enough momentum to ensure that the world growth prospects remain strong.

But remember that those twin deficits - the fiscal deficit of 4 per cent of GDP and the current-account deficit of 5 per cent of GDP - remain in the background. So far, they have not led to the collapse in the US dollar that some have forecast, but the danger remains. Just like the Republic after the last election, the US may face a bit of "payback" time post November.

Of course, the Republic has passed through this phase and our economy now appears in good health again. Tax revenues are firm and both business and consumer confidence is high. The jobs market - the source of such doubt in the big economies - is extraordinarily healthy here.

We may not be back to the situation in 2000 when there were more jobs available than there were people to fill them, but even the cautious Central Bank said in its latest report that the jobs market was "tightening".

For the moment, it seems that, given any kind of favourable international wind, our economy can prosper.