Merrill Lynch Canada Inc, concedes that the terrorist attacks on the U.S. yesterday may inflict some short-term economic pain, but the brokerage firm suggests the economic recovery could be made more powerful by the rebuilding effort.

“The near-term outlook has of course become very clouded, but we want to stress that while September 11 will never be forgotten, we believe that panic will not prove profitable,” says the firm in a report issued today. “As difficult as it is to imagine today, these sorts of tragic events generally have not had a lasting effect on the economy or the investment landscape.”

“To be sure, whatever the odds of a global recession were on Monday (and some were already talking of such), those odds have since gone up,” says David Rosenberg, Merrill’s chief Canadian economist and strategist.

The firm suggests that the Fed will be much more aggressive in easing rates, sooner rather than later, for the dual purpose of adding liquidity and building confidence. “As we saw in 1987, the Fed must play a key role in helping revive investor confidence. There will undoubtedly be a near-term disruption to business activity. We would also have to think that U.S. consumer sentiment, already fragile, will deteriorate.”

Merrill insists that it would be a mistake to underestimate the resilience of the Americans’ spirit, but that, “It would be prudent to expect the global economy to weaken through to year-end and possibly early 2002 (though keep in mind that many investors have long ago priced in a full-fledged recession). Even among the optimists, recovery prospects have been pushed out to the back half of next year.”

Merrill sees upside risk in that a powerful monetary and fiscal policy response in the rebuilding effort could mean that “the eventual economic turnaround could be more vigorous than anyone currently expects, especially since today virtually everyone is focussed on the very worst.”

“In this period of heightened economic and financial uncertainty, we would be looking for a ‘flight to safety’ effect to take hold near-term. So look for the yield curve to steepen, as is generally the case following catastrophes of any kind. This steepening will probably be led by yield declines at the front end of the curve since investors will focus on liquidity, and right now that’s contained in T-bills and the 2- and 3-year part of the government bond market.” Merrill says that the bottom line is that interest rates will likely come down sharply, “so within the equity market, ‘bond proxies’ like high-quality financials, pipelines and utilities may prove for a while to be ‘safe havens’.”