Key central banks fail to provide direction as they take very different views on the current economic and financial outlook

The recovery in stock prices during October has run out of steam so far in November. In many markets the rise in share prices during October was sufficiently large to qualify as a "mini-bull market" in the view of some analysts.

However, most stock market commentators would have been concerned that the speed and magnitude of the October recovery was consistent with the view that it was merely a recovery within a continuing long-term bear trend.

The accompanying table shows the recent performance of equity markets and highlights the dilemma that now faces investors. Over the quarter to date, most markets are still enjoying a healthy recovery of the order of +10 per cent, which could mark the beginning of a more sustained upward trend.

However, the week to November 11th has witnessed a pullback in most equity markets. For example, the ISEQ Overall index is down 3.9 per cent, the Dow Euro Stoxx is down 5.7 per cent and the Nasdaq is down 5.5 per cent.

If this more recent negative trend persists, it will not be long before some investment analysts will start to speculate as to whether markets will retest the lows reached during September. In essence, equity markets remain on a knife-edge with no clear discernible short-term trend in place.

Against this uncertain market backdrop, the most significant recent financial development was the meetings of the world's three key central banks - namely, the Federal Reserve, the European Central Bank and the Bank of England. By coincidence, all three banks met within days of each other.

If investors were looking for actions that signalled a concerted move from these central banks that indicated a clear view of future trends, they were sadly disappointed. One, the Fed cut interest rates more aggressively than expected, while the other two left rates on hold. This would seem to suggest that these three key policy-makers take very different views as to the current economic and financial outlook.

By cutting the Fed Funds rate to 1.25 per cent, the US central bank clearly signalled that it viewed the prospective US economic situation with deep concern. On the other hand, the ECB left Euro interest rates at the much higher level of 3.25 per cent.

The proverbial observer from Mars might find it very hard to understand these apparently divergent actions. So far this year, the US economy has in fact grown at a faster pace than the European economy. It is true that forward-looking indicators of consumer confidence and investment intentions have weakened sharply in the US. However, equivalent indicators from Europe's larger economies such as Germany and Italy paint a picture that is just as bleak. With euro interest rates so much higher than dollar rates, the man from Mars would be very confused.

The Fed's action indicates that the US central bank is very concerned about a Japanese-style global deflation. If the Fed is correct in its assessment of the deflationary threat, then the ECB is clearly pursuing the wrong policy in keeping euro interest rates at current levels.

As for the Bank of England, its inaction does seem to be the right course for the UK economy. Just days after the Bank of England announced its decision to keep rates on hold, house price data were published showing that the annual increase in British house prices has now hit 30 per cent. This is a rise of Celtic Tiger proportions and has raised fears in Britain that a housing asset price bubble may be in the making.

The key problem for British policy-makers is not the overall level of activity, but the fact that that activity is very unbalanced. The service and consumer sectors are flourishing but the manufacturing sector is in the doldrums. A cut in interest rates would have been of marginal help to the manufacturing sector, but would also have acted to fuel an already booming housing market.

The apparently divergent views of the world's most powerful central bankers merely adds another layer of uncertainty to an already volatile investment environment.

Investors will continue to look for signs that the ECB may change tack and lower interest rates after all. In the meantime, all eyes will remain firmly focused on the US economy on which so much still depends.

With Japan remaining in the doldrums and Europe seemingly gripped in a policy paralysis, the global economy is now more dependent than ever on the United States.