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June and July were dismal months for the stock market. But August has finally brought some good news. The oil price drop no longer looks like a blip but a sustained decline. Anyone who has been asleep for the last 12 months might consider $120 a barrel to be a fortune but it is a lot better than $147. Suddenly £1.15 a litre at the petrol station looks reasonable.

It may take a few months but lower oil (and other commodity) prices will eventually have an effect on headline inflation. That will negate the need for any further interest rate tightening by central banks. Earlier this year, the market was expecting several rate rises from the Federal Reserve; after the Fed’s August meeting, they are expecting none. Even the European Central Bank, an arch-inflation hawk, has probably done its worst.

That is key because the European economy looks pretty ropey. Germany contracted in the second quarter; the UK numbers may be revised to show a minimal output increase. Spain and Ireland are beset by housing-related problems. Central banks could have done nothing about this if inflation remained high; now there is the potential for them to cut rates, maybe not until the New Year.

Although corporate profits are clearly going to deteriorate from here, it is just possible that the markets will look through the downturn to the recovery beyond. In the past, lower interest rates have often been sufficient to prompt a market recovery.

The key question is just how far corporate profits have got to fall. Reported earnings for S&P 500 companies dropped about 40 per cent in the 2000-02 downturn; the profit margins of non-financial US companies peaked at 12 per cent in 2006 and are still nearly 10 per cent; they dropped to around 3 per cent in 2002, according to the Bank Credit Analyst. Even price-earnings ratios of 10-11 for the UK market may not be much protection if profits drop as far as they did last time.

The big worry is that deleveraging, once begun, may prove impossible to stop. Banks are still writing off their sub-prime losses and now may face the normal write-offs associated with an economic downturn. That will make them more cautious about lending, making consumers more cautious about spending. Bank credit spreads remain as high as they were in March, when Bear Stearns was in trouble. There is always the possibility that, with credit tight, speculative investors like hedge funds may have to cut their positions.

The best hope is the emerging markets. Yes, it may be true that they have been responsible for driving up commodity prices in recent years. But countries like China and India have an internal growth dynamic that is partly independent of the US and Europe; they will keep the global economy ticking along and create opportunities for exporters in developing countries.

Nor should we forget technology. For all the froth that surrounded the dotcom bubble, the internet has been an amazing tool for making markets more efficient by removing barriers between markets and making buyers and sellers more aware of prices. It has provided a background boost to global productivity.

These factors are very much long-term ones and may not provide much comfort in the next few months. The best triggers for a rally, as the Bank Credit Analyst remarks, would be a further fall in the oil price (below $100 would be great), a moderation in the rate of US house price deflation (not yet) and a drop in credit spreads (this has happened for non-financial companies but not, crucially, for banks). When all three are in place, there is scope for a quite vigorous stock market rally.