Has fear staged a return to markets at last?

Last month, the Office for National Statistics underlined the problems facing the UK when it revealed the country's gross domestic product fell by 0.8% in the second quarter.

The FTSE-100 index of leading shares did not stutter. In continued on a run which saw it clock up 11 consecutive sessions of gains - the joint-longest winning streak since the index came into being in 1984.

Last Wednesday, Bank of England Governor Mervyn King hammered home just how long it was likely to take the UK to get back to the levels of economic output prevailing before the current deep recession.

As he noted himself, this is a matter of simple arithmetic. (Then again, if the last couple of years has reinforced anything, it is that events in financial markets do not always add up).

King highlighted the likelihood that unemployment would continue to rise for a long time because the spare capacity created by the deep recession would not be eliminated quickly even if UK growth were to return to a slightly above-trend annual pace approaching 3%.

The Bank of England's latest quarterly inflation report, which King was presenting last Wednesday, meanwhile highlighted a raft of hurdles to economic recovery. And it pointed to UK base rates remaining at an all-time low of 0.5% well into next year - a projection which underlined still further the huge challenges still facing the economy.

The UK stock market had wobbled last Tuesday, ahead of the Bank's inflation report.

However, the FTSE-100 rose on Wednesday. It appeared to shrug off King's message that even a return to roughly trend growth in the UK was unlikely to feel anything like recovery given the depth of the recession.

And even King's warning that it would take UK banks "several years" to repair balance sheets did nothing to dampen stock market sentiment.

The government and Bank of England have put restoration of normal lending patterns at the heart of their policy agenda. King appeared to be saying not to expect any such normality any time soon.

On Thursday, the FTSE-100 even progressed to fresh 10-month highs, helped by news that the French and German economies had each made a surprising exit from recession in the second quarter with growth of 0.3%.

It seemed that players in financial markets were not that interested in hearing why they should keep their feet on the ground but were tuned into the good news channel.

However, stock market sentiment is a fickle thing indeed.

In the end, it was Friday's University of Michigan consumer confidence survey which at last provided the reality check. This showed an unexpected fall in US consumer confidence in early August. The drop was sharp, and it was the second consecutive monthly fall.

Wall Street stumbled. The Dow Jones Industrial Average finished down 76.79 points on Friday, even after clawing its way off that session's worst levels.

Yesterday morning was, in terms of developing stock market psychology, very interesting. Over the weekend, financial market players had the chance to contemplate whether things might have gone up too far, too soon.

But the week kicked off with a significant piece of good news. Official data revealed the Japanese economy had emerged from deep recession in the three months to June with quarter-on-quarter growth of 0.9%, as this country's exports leapt and a huge fiscal stimulus package boosted output.

Yet Japan's Nikkei 225 average dropped more than 3%. This was in contrast to the general stock market reaction to last Thursday's news that the French and German economies had exited recession.

It appeared that traders in Tokyo yesterday focused less on the Japanese economic data and more on Friday's news of the fall in US consumer confidence.

This negative sentiment continued to dominate as European stock markets began the week. Several hours later, it was Wall Street's turn. The US stock market fell sharply when it reopened after the weekend.

The UK's FTSE-100 had surged from a close of 3512.09 on March 3 this year - its worst finish since the Iraq war month of March 2003 - to a 10-month finishing high of 4755.46 on Thursday. Between Friday and yesterday, it has fallen more than 110 points.

The sharp rebound in global stock markets since March was driven mainly by the growing belief that what the major world economies have been facing is deep recession, with the danger of a much more damaging episode of depression and deflation having receded sharply. (It should be noted that China has continued to grow throughout and there have recently been state measures again to prevent it over-heating).

In terms of the sharp rebound in equities since the spring, it is difficult to assess just how high share prices should have moved on this relief that we do not appear to be looking at economic depression. This relief has to be weighed against the grim reality that it is, in many of the big world economies, probably going to take many years before it feels like the pre-recession days.

Some countries will fare better than others.

While it is absolutely good news for the global economy that Japan has pulled itself out of recession, this exit does raise further potentially troublesome questions about why the UK is lagging. Similar questions, in fact, to those posed when it emerged last week that France and Germany had beaten the UK out of recession.

It would be dangerous to judge too much on a single quarter, and it is worth remembering that the Japanese and German economies did take a real tumble when world trade slumped.

And we should not lose sight of more upbeat survey evidence for the UK economy in July, even though some were too quick to predict a return to growth in the UK in the second quarter on the strength of such surveys.

All of that said, it is at least a touch worrying that the UK and US, among the major nations, probably had the greatest direct exposure to the global financial shambles, and that both stayed stuck in recession in the second quarter.

And the UK's pace of decline, for the record, was significantly sharper in the second quarter than that in the US.