Hamish McRae: There's more gloom coming but it won't last for ever

There is an excess of information. We are being told too much and the noise is drowning out the signals. That is certainly happening, as you would expect, on the battlefield, for wars are always confusing. But it is also happening on the economic front for it has become particularly hard to judge whether each new piece of partial information really tells us much that is new. What does, however, suffuse all the flow of information is a sense that demand worldwide is likely to disappoint.

There is an excess of information. We are being told too much and the noise is drowning out the signals. That is certainly happening, as you would expect, on the battlefield, for wars are always confusing. But it is also happening on the economic front for it has become particularly hard to judge whether each new piece of partial information really tells us much that is new. What does, however, suffuse all the flow of information is a sense that demand worldwide is likely to disappoint.

Let's start with, so to speak, the case for the prosecution. Yesterday there was the new Ifo survey of German business confidence. For some reason the markets had expected it to perk up, though anyone who has spent any time in the last month talking to German business executives would have been wholly unsurprised by the fact that it didn't. I have seldom met such a depressed lot – the sort of conversations I had last week in Frankfurt are reminiscent of those in Japan four years ago. It seems pretty clear that Germany will have another recession in the first half of this year and will be lucky over the year as a whole to manage much more than the 0.2 per cent growth it achieved last year.

If Germany does, as seems likely, remain at the bottom of the European growth league (see left-hand graph) this is bad news for the eurozone as a whole. If the eurozone scrambles 1 per cent growth this year it will be doing quite well given the drag from its largest member. The only large European economy on those forecasts (from HSBC) that is likely to achieve more than 2 per cent growth is the UK, which is of course outside the zone.

Other bits and bobs of forward-looking information are in similar vein. Belgian industrial confidence (quite a good lead indicator for the eurozone as a whole) was down sharply too. Italian and French data this week has also been glum.

As a result, everyone has been busy scaling down growth forecasts. One should not take these forecasts too seriously for in the past they have been spectacularly wrong: Germany started last year expecting 2 per cent growth. But the bias I fear is to undershoot rather than overshoot. Were the euro to continue to strengthen, exports, the main source of additional demand in Germany last year, will presumably go soft.

If Europe remains flat, what about America? The Conference Board's survey of US consumer confidence, out on Tuesday, was the worst since October 1993. This is important for, as is widely known, consumer demand has been the one thing sustaining the US and indeed the world economy through the past 18 months. But it is dependent on borrowing and if people are not very confident they are unlikely to want to carry on increasing their borrowings. The war gives a handy excuse to cut back. The longer it carries on the longer the effect.

But maybe people simply delay their purchases? Well no. In a world where the bulk of consumption is buying goods that would to some extent be true. But in a world where the bulk of spending is on services it isn't. You can delay the purchase of a car or a fridge but if you don't buy an airline flight or a hotel room that sale is lost forever. Retail sales are now only about one-third of consumption: the rest is services.

What about other forms of demand in America? Well the surge in Federal spending helps of course but the most cheering thing for US producers is the possibility that the dollar might fall a bit further. The middle graph shows the exchange rate against the euro since 1979 – a synthetic euro calculated from the various European currencies before 1997. As you can see the dollar is not yet nearly as weak as it was during the last recession. The view of Cazenove's economic team, which drew attention to this point, is that it could fall much further as investors around the world baulk at the US current account deficit. I suppose it is at least plausible that the dollar could become a victim of war.

But who will the US export to? Not Europe because there won't be enough demand. Not Japan because it doesn't import anything it does not have to. (Japan imports less than the UK despite having double our population.) China? A bit, sure, but not a huge amount. Latin America? They can't afford to buy much. Britain? Not big enough to help in a material way and our consumers are about to be clobbered by a round of tax increases.

So you keep coming back to the awkward question: where on earth is demand going to come from?

Assume that the war ends about the middle of the possible range: not the most favourable but not the least favourable either. In a few months' time there will be a reasonably stable civil administration in Iraq and the conflict will have been contained. There will not be any sudden revival in confidence and the lacklustre consumer demand noted above will have depressed the world economy. We may even have a second leg of recession in several large economies.

Nevertheless there will be a general perception that the worst is past and that there will be several years of growth – slowish growth but growth none the less. Helpfully, the bear market will be over. Here in Britain that last little vicious dip took the FTSE 100 index below its previous bottom last autumn but as you can see from the right-hand graph, in the US it is possible that last October was indeed the bottom. Of the three final downward lurches, October 2002 was the worst.

The case for the defence – the defence that argues that amid all this bad news there are modest signals of hope – rests on three planks.

Plank one is the familiar one that economies are self-healing. People like consuming and will do so unless they are feeling seriously insecure. Plank two is the equally familiar one that technology will continue to advance, cut costs, produce new services and products, increase productivity and generally generate growth.

And plank three is that money will be cheap for the foreseeable future. The downward pressure on prices is considerable, except in particular protected areas such as public sector services. US rates will remain low and eurozone rates will fall – UK rates will fall too if that is needed.

You don't hear so much from the defence advocates, for their voices are drowned out by the string of negative economic news. It is absolutely right to say: where will demand come from? It is reasonable, however, to reply that there will not be much this year and that there may even be a couple more sub-standard years to come. But the job of markets is to anticipate and just as their gloom of the past three years now seems justified, at some stage their confidence will return.