Economic reality finally cracks market fervor

As evidence mounts that a mid-year slowdown taking place in the world economy, the next few days will offer a clearer glimpse of how that will impinge on policymaking and buoyant financial markets.

Global stocks stumbled last Thursday in one of the few times the grey economic reality cut through this year's reverie in financial markets.

And that could mark the start of a trend, after Federal Reserve Chairman Ben Bernanke last week hinted the U.S. central bank could soon scale back its monthly bond purchases that have flooded stock markets with new cash.

Some poor business surveys from China have also had an impact, suggesting the world's No.2 economy is struggling for momentum.

While there is little in the way of major economic data this week that will send chills through stock markets as happened on Thursday, there is a renewed sense of caution in the market.

"The underlying momentum in the global economy is weaker than it should be at this point of the economic cycle, five years after the global crisis," said Lena Komileva, director of G+ Economics consultancy in London.

"We have yet to see evidence of a convincing, self-sustained positive feedback loop between real growth and market value inflation."

Hope that market confidence would filter through to the real economy was memorably described as "positive contagion" by European Central Bank President Mario Draghi in January - in hindsight perhaps more in hope than expectation.

Growth is still proving to be elusive for the euro zone economy, largely thanks to the extent of the budget austerity taking place across the continent.

On Wednesday, the European Commission will release its review of its countries' debt-cutting policies, which will confirm that the likes of France, Spain and Slovenia are to be given more time to trim their budget deficits to target.

The Organisation for Economic Co-operation and Development's semi-annual review of the world's major economies will come out on the same day, having identified global economic activity "picking up" in its interim assessment in March.

Now, the world economic growth seems to be moving into a soft patch, although there is no sign of anything that will curb it significantly.

Last week's purchasing managers indexes showed factory activity in China declined slightly for the first time in seven months, while in the United States manufacturing grew at its slowest pace since October.

"These surveys suggest that the Chinese economy is doing a bit worse than expected and the euro zone marginally better, but they do not alter our view that global growth will remain weak, and imbalanced, for the rest of this year," said Andrew Kenningham, senior global economist at Capital Economics.

He noted, however, that economies like the UK and Japan that weren't covered in last week's PMIs have performed better than expected in recent months, so the global economy could be slightly stronger than the surveys implied.

TAKING STOCK

Since last Thursday's stock markets wobble, analysts are largely agreed that period of moderation, rather than a big correction, lies ahead for risk assets.

European markets have been particularly sensitive to shifts in sentiment over the last few years, and three Italian government bond auctions next week will provide more clues on investor intentions.

Spanish yields rose at auction for the first time in three months in the past week, and the Italian auctions will provide further interest because they will be the first since Fed Chairman Bernanke hinted that waves of new cash from central banks will not go on forever.

Governments in the euro zone's most vulnerable economies, like Spain and Italy, have benefitted hugely from reduced borrowing costs resulting from easy cash flowing out from the Fed and Bank of Japan, and into their bonds.

That of course applies to stock markets too, and Bernanke's intervention will set a new tone on global bourses in the coming weeks, marked by increased uncertainty.

The Euro STOXX 50 Volatility Index, Europe's widely used measure of investor risk aversion, surged 13 percent to a three-week high last Thursday alone.

"We remain positive on equities in general ... (but) more broadly, equity markets may lose some momentum now that they must worry about stimulus withdrawal," said Guy Foster, head of portfolio strategy at Brewin Dolphin.

(Additional reporting by David Brett; editing by Ron Askew)