Falling prices no reason for distress

Under normal circumstances a rise in bond yields accompanied by strong economic growth would hardly be a surprise. But the global economy and financial markets have behaved so abnormally for so long that the movements of the past few days require careful examination — especially given that the falls in fixedincome markets have been accompanied by sharp drops in equity prices.

The negative scenario is that, in a world in which inflation has remained stubbornly low, bonds are entering a bear market not because nominal long-term economic growth is likely to be high, but because they were heavily overbought and are now experiencing serious correction. Indeed, if the movements in the bond markets are linked to the expected withdrawal of quantitative easing across much of the developed world, it may simply turn out that the markets were on an artificial high all this time.

Certainly, the continued absence of signs of sustained inflationary pressure, together with little change in the medium-term expectations of the US Federal Reserve raising interest rates, should give some pause. But the movements in financial markets so far are nothing particularly dramatic. Most probably, the falls in bond prices reflect investors downgrading the likelihood of a destabilising deflation. As such, it is to the good.

It is unsurprising that there should be a correction at some point, and that it would come alongside higher longterm interest rates. At this stage there is no need for anyone — and certainly not policy makers — to panic at events in the financial markets.

The global economy is in a broad-based upswing, there are no signs inflation is running out of control or that central banks will have to tighten policy suddenly. There is also little evidence that markets have become disorderly. While that risk remains, price movements so far are consistent with the world edging back towards some sort of normality. London, February 5