Creaking and grinding, the global economy accelerated during the summer months. Some of the Asian economies so badly hit by the 1998 financial crisis began to motor, and Germany's export orders responded to an improvement in global demand. The US economy, meanwhile, continued to roar ahead, fuelled by rampant consumer demand and strong corporate investment.

As happens so often, however, the securities markets failed to respond positively to this economic strength. It is a common feature of the economic cycle that financial asset prices rise fastest at the outset, the turning-point of sentiment, when investors believe the worst is past. Later on, however, they become worried about some of the negative features of an economic upturn, such as inflation and rising interest rates.

A year ago, the leading central banks moved aggressively to cut interest rates and pump money into the crisis-stricken global economy. The US Federal Reserve cut short-term interest rates to 4¾ per cent and during the spring, the newly-established European Central Bank reduced rates to a low 2½ per cent and the Bank of England edged down to 5 per cent, the lowest UK short-term rate for more than 20 years. In Japan the rate has stayed at about zero.

The cheapness of money has favoured stock and bond markets, and for a while spare industrial capacity has helped to hold inflation at a low level in most of the world. In the UK, by September, headline annual inflation was only 1.1 per cent.

During the summer, however, the UK and US (the latter twice) raised interest rates in quarter-point stages, and while the ECB stayed on hold, signs emerged that liquidity growth in the euro area was slowing down. The central banks were happy when buoyant liquidity remained trapped in the securities markets but they appeared to become concerned when prices began to rise in the oil market - the price of Brent crude jumped by 35 per cent in the July-September quarter - and the gold bullion price leapt at the end of September.

Were these inflationary portents? Not exactly, at any rate for the time being: the oil and gold price rises reflected cuts in supply rather than excess demand. The broadly-based Reuters commodities index was slightly down over the quarter. But there was mounting concern over the increasing tightness of the US labour market, though pay inflation has stayed remarkably moderate.

True, the US has successfully imported low inflation through a bumper flow of imports which pushed the average monthly trade deficit to near $25bn during the third quarter. But foreigners have to remain willing to finance this spending binge on imports.

Through the summer, economists were working out the sums. If the foreigners who accumulate the dollars are willing to hold on to them, or can find other dollar-hungry non-Americans, the funds will eventually flow into the US bond market and Wall Street equities. This is a marvellous "new paradigm". But what happens if the foreign investors get worried, perhaps by an acceleration in US inflation? The dollar could weaken, bond yields would rise and Wall Street could weaken and, perhaps, crash because of big rises in US interest rates. In essence, the US authorities would have to tighten monetary policy sharply to correct the trade gap. That looks like a rather nasty old paradigm.

At any rate, the third quarter saw government bond yields rising modestly on both sides of the Atlantic. The dollar wobbled worryingly against the Japanese yen, falling by 12 per cent over the three months, but it almost held its own against the European currencies.

any stock markets hit new highs in July but failed to sustain them as confidence wavered with the relentless approach of another threatening October. The FT/S&P Actuaries World Index dipped by around 6 per cent in terms of sterling during the three months.

The best action was in Greece where convergence towards the euro is boosting the markets and the equity index was up 26 per cent during the quarter. On the other hand Indonesia hit big trouble in the shape of the East Timor crisis, and its index slumped by a third. It had done so well in the first half of 1999, too.

As for the UK, the equity market hit an all-time high on July 6, but it has lacked the high-technology exposure which sustained Wall Street's strength for a few more weeks. London was tantalised, though, by the flotation at the end of July of Freeserve, the Dixons website subsidiary which has all the flawed appeal of the US internet sector - no profits, no history but just possibly a wonderful future. London has been starved of glamorous new issues and this one looked interesting. Subscribed 20 times over, Freeserve's share price zoomed from an issue price of 150p to over 240p but before the quarter-end had crashed back to 123p.

It was not, however, the wonders of technology but rather the problems of mainstream companies that came to preoccupy investors in London. Leading retailers were somehow hitting trouble during a period of buoyant consumer demand. Marks & Spencer's share price slipped steadily against the background of terrible results and mayhem in the boardroom, and things were hardly any better at J. Sainsbury. Another major blue chip, British Airways, was struggling in a different sector. Common factors have been too much capacity and not enough high-paying customers.

In fact, many of the big blue chips have been fighting to hold their share prices for much of the year. The economy is changing but traditional companies often find it hard to adjust. There is much speculation about the impact of the internet. Action has tended to switch to smaller stocks, but even this has been inhibited by the interest rate rise. The FTSE SmallCap Index rose only 1 per cent during the July-September quarter, but this was still better than the 4 per cent All-Share Index fall.

Takeovers have remained a positive influence, however, with Wal-Mart paying £6.7bn for Asda in August - although the arrival of the super-competitive US retailer in Britain did nothing for the rest of the retailing sector. Elsewhere there was a lot of corporate action across Europe in the telecoms sector.

The London stock market's favourite sector for takeover speculation - banking - had a disappointing summer, though. Overseas, huge banking mergers were launched in countries ranging from Japan to France but British banks stayed aloof. Then at last, in September, NatWest launched an abortive bid for Legal & General only to put itself in play for a bid from Bank of Scotland.

This restored market sentiment but subsequently a typical October scare has dominated. Investors have seen London house prices perform far better than UK share prices in the third quarter which may partly reflect buoyancy in the "buy to let" sector. Conditions are not like they were in the late 1980s; but there are some passing similarities.


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