Crisis easing, but economic damage yet to be felt

Recent data suggest the economy’s strong start to the year was mostly sustained in February, with consumption growth set to accelerate in the first quarter, payroll employment growth robust and, partly reflecting that strength, core inflation still much too high for comfort. But events over the past couple of weeks have made us more confident in our view that this strength won’t last. While the immediate crisis in the banking sector appears to be easing, it remains to be seen how big a blow the turmoil will deal to confidence. With small banks in particular under pressure to shore up their balance sheets, the main risk is that lending standards – which were already being tightened to a degree usually only seen in and around recessions – will be tightened significantly further. That will weigh on business investment and durables consumption, and reinforces our view that the economy is likely to fall into recession this year as the full effects of the Fed’s monetary tightening feed through.