* Commodities plunge could be relief rather than warning
* Rate rise pressures to ease if inflation forecasts ebb
* Factories cooling, but more sustainable pace may be benign
By Mike Dolan
LONDON, May 6 (Reuters) - This week's commodity market fright at the cresting of world economic growth looks oddly panicky and easier oil and raw materials prices may themselves reinforce a more benign outlook than the market scare suggests.
For all that speculative ebb and flow is inherent in most financial markets, the sudden plunge in energy and metals prices was seeded by series of soft business surveys from the United States, China and elsewhere showing sky-high crude prices were starting to brake buoyant business confidence and activity.
Add in some weak signals from the U.S. labour market in the form of a sharp jump in weekly unemployment claims and jitters about the release next week of the latest Chinese inflation and production data and a brutal retreat in commodities ensued.
At its low just above $105 per barrel on Friday, Brent crude oil had lost more than 12 percent since Wednesday alone, the biggest two-day fall since the financial crisis over two years ago.
But should the other financial markets, businesses and households run scared too or should they breath a sigh of relief that dangerous and inflationary commodity market excesses may have been lanced for now at least?
For many leading economists, the answer is the latter.
Some slowdown in breakneck industrial production growth is due and warranted, they argue, as the bigger risk to world growth going forward is one of overheating commodity demand that exaggerates headline inflation further and forces central banks to react by tightening credit and slowing their economies.
In that respect, the commodity retreat is welcomed with open arms by policymakers such as European Central Bank chief Jean-Claude Trichet who have been trying to stem inflation fears by pushing up interest rates from supereasy, credit crisis lows.
"It (the commodities retreat) is good to take in terms of consolidating the recovery because any increase in the price of oil and commodities has an inflationary impact and a depressive impact (on growth)," Trichet said on Friday.
Economists at U.S. bank JPMorgan echoed that view, telling clients late on Thursday that if the drop in oil and food prices are maintained, "they will provide unexpected relief on inflation and household purchasing power."
Looking outside the United States, UK bank Barclays reckons that if a lower trending oil price of around $111 per barrel for Brent oil were to replace its existing assumption of $120, then its euro zone and UK inflation forecasts for this year would both be cut by 0.2 percentage points.
Significantly, that would then mean euro zone headline inflation peaked at 2.8 percent last month as opposed to topping out in the autumn at 3.0 percent.
BIG PICTURE
So, how does that fit into the big picture of world growth?
In broad context, sudden fears of a slowdown seem strange as a slight ebbing of a booming world economy this year has been the running assumption for months.
The International Monetary Fund, for example, already expects global growth to slow from 2010's blistering 5.0 percent to 4.4 percent this year -- even though that's still more than a percentage point above the 20-year average and it sees that pace at least sustained through 2012.
Using monthly business surveys from around the world as a weather vane for the twists and turns of activity shorter-term, it's clear that world manufacturing output -- expanding at annualised rates of a whopping 10 percent plus coming into this year -- has been the big driver of the recent boom.
But, as JPMorgan points out, this surge was not matched by final expenditure on goods and so unsold inventory in auto factories and the like started to stack up -- presaging a cooling of assembly lines and a drop in global manufacturing growth rates to an estimated 3.5 percent in April.
And that's why the outlook now hinges on sustaining final demand to start clearing that inventory, and hence the growing importance of the inflation and interest rate scenario on household behaviour and the overall growth picture ahead.
The big problem then for most economists and markets in the short term is twofold.
First, they are trying navigate a significant amount of erratic and likely short term economic data swings related to Japan's earthquake disaster, extreme weather -- such as the damaging U.S. tornados - and the fact that oil price swings themselves were likely exaggerated by the unprecedented unrest across the Middle East and North Africa.
Big output shocks in Japan, the world's third biggest economy, will likely distort aggregate global growth data for months, but most experts expect much of that to be corrected in the second half of the year as the country recovers rapidly.
And in the meantime, some argue, Japan's export hiatus may actually help drain inventory piles in competing manufacturers elsewhere in the world -- ironically sustaining output growth outside Japan for longer until its recovery kicks in.
MONETARY GUESSWORK
The second puzzle is the difficulty in parsing the inflation outlook and how the world's major central banks respond. And here's where commodity prices become as much of a driver than a reflection of the outlook.
Jim'O Neill, Chairman of Goldman Sachs Asset Management and a long-standing optimist on world growth, told clients this week the persistence of commodity-driven inflation in China and the rest of the world was his one gnawing concern about the prospect of what he terms a "happy slowdown".
"Some softening (of business activity) wouldn't be overly troubling, as we have risen so much in recent months, and any softening would simply add to the inclination of most Western monetary policymakers to be extremely slow in tightening monetary policy, if at all," he said.
He added that in the light of China's strategic plan to slow its economy slightly over the coming years and tilt more toward local consumption away from exports, "I can't see the case for so much bullishness on commodity prices."
"Moreover, if commodity prices were to ease, I can't really see the case for fears about inflation around the world."
(Editing by Toby Chopra)