IT IS known as the “reflation trade”. The theory is that rich-world central banks will do whatever it takes to revive their economies, even if that means tolerating a period of above-target inflation. As a result, investors feel an incentive to buy “real assets”, those linked to nominal economic growth (notably equities) or to rising prices (commodities).

From October 4th to March 1st, the MSCI World equity index rose by 21.4% and the S&P GSCI commodity index rose by 23.8%, vigorous rallies by any standard. Bullish sentiment was driven by a sense that quantitative easing (QE), the creation of money to buy assets like government bonds, had become a competitive sport.

America and Britain had been in the vanguard but in September the Swiss central bank pledged to create sufficient money to peg the franc against the euro; and in February the Bank of Japan added {Yen}10 trillion ($128 billion) to its asset-purchase programme and unveiled a target inflation rate of 1%. For its part the European Central Bank has lent more than €1 trillion ($1.3 trillion) in three–year loans to banks, in what is widely seen as a case of QE by the back door.

But the reflation trade took a bit of a dent on February 29th when Ben Bernanke, the Federal Reserve's chairman, gave no hint of a third round of QE in testimony to Congress. Admittedly, there was a bullish underpinning to Mr Bernanke's speech: a better performance by the American economy means there is less need for further action. Nevertheless, the Fed is seen as “pump-primer in chief” by many in the markets. Gold fell by $100 an ounce after Mr Bernanke's statement.

A setback was probably inevitable after such a strong rally. A bigger question, however, is whether the rationale behind the reflation trade makes any sense.

Central banks have undoubtedly expanded their balance-sheets during the crisis. Back in 2008 the monetary base of the euro zone (in effect notes and coins plus reserves held at the region's central banks) was around 10% of GDP; the equivalent figures for the Federal Reserve and the Bank of England were in the 4-6% range. Now the monetary base in all three places is between 16% and 18% of GDP.

However, expansion of the monetary base does not necessarily lead to growth in broad money, which measures the supply of credit to businesses and consumers and which ultimately drives inflation. Money-supply growth still looks sluggish in Britain, Japan and the euro zone (see chart). Only in America does it look robust.

The problem is that many banks remain unwilling to extend credit given the need, among other things, to shore up their capital. Figures show that total euro-zone lending to households and non-financial firms has declined in recent months, despite the ECB's actions. Dhaval Joshi of BCA Research says that “banks have destroyed money just as fast as the ECB has created it.” Jennifer McKeown of Capital Economics concludes from the data that “bank lending remains extremely weak, suggesting that a lack of credit will continue to hold back economic activity.”

In short, the reflation trade may be based on a false premise. The rally may well have been driven by a lifting of the intense economic gloom that enveloped the markets in the autumn of 2011 and a sense that the European authorities had removed the immediate threat of a banking collapse, while simultaneously halting the rapid rise in Italian and Spanish government-bond yields. But now that investors have paused for breath, they can see that the economic outlook is still pretty murky. On March 5th, for example, China lowered its growth target to 7.5% (see later story); survey data on activity in the euro area's services sector were also weaker than expected.

Furthermore, the markets are starting to lose a key source of support. As the global economy emerged from recession in 2009, profit margins surged thanks to falls in borrowing costs and weak wage growth. But European profits are down by 7% compared with the previous year, according to HSBC. Even in America, which is doing rather better, Bank of America Merrill Lynch is expecting corporate profits for S&P 500 companies to grow by just 6.4% in 2012, down from 14.8% last year.

It all looks remarkably like 2011, when an early-year rally also ran out of steam. So long as the yields on other assets like bonds and cash are so low, it is hard for stockmarkets to collapse. But those yields are so low because central banks are frightened about the economic outlook. That makes it very hard for a bull run to be sustained.