Fair Winds and Following Seas

27/03/2015 at 4:41 pm

Market chat on the subject of the eurozone has tended to be rather downbeat over the last few years. Some observers have focused on its benighted wrangling over sovereign debt; others, more recently, on the supposed millstone of deflation. And there have of course been those who have questioned the zone’s very future. Narrative gloom set in well before the double dip recession’s second leg, persisted throughout it (Q4 2011 – Q1 2013) and has continued since. Today, however, the fundamentals are refusing to play ball even more stubbornly than they usually can, when the mood takes them.

Earlier this month we saw the ECB revise its growth forecast for 2015 up from 1.0% to 1.5%. Just this week, consumer confidence in the eurozone hit its highest level since the short-lived spike up into July 2007. And the composite output indicator showed the strongest level of growth since May 2011, before the market crash and pandemonium which dominated the second half of that year.

There are three major reasons for this.

  • The euro has depreciated. It has fallen by over 20% against the dollar over the last nine months (from 1.365 to 1.088) and more modestly against sterling and the yen also (-8.7% and -6.5%).
  • This real world monetary easing has been matched by the ECB’s first foray into quantitative easing. Dubious though the policy’s concept and effects may be, markets have tended to approve of this.
  • The eurozone collectively is the world’s largest net importer of crude oil. Though the euro has got cheaper, oil has got cheaper still: the near Brent crude future is 36% lower in euro terms today than it was nine months ago.

Against this background the strong performance of European equity markets versus their developed-world peers is understandable. (The Stoxx 50 is up by 17% so far this year as against 11% for the Nikkei, 4% for the FTSE 100 and zero for the S&P.) The question is: can it last?

Disaster notwithstanding, the answer might just be “yes”.

The benign effects of cheap oil on the US as another significant net importer are offset by fears over monetary tightening in the face of a galloping labour market. These intensified last week when the word “patient” was removed from the formal description of the Fed’s present monetary stance. The Bank of England is similarly looking to tighten policy at some point as affirmed by Governor Carney only this morning. Before the oil price collapse began to be felt in earnest there were signs of price pressure in these economies and should the collapse unwind at all into the end of this year those signals will get stronger and stronger.

The unemployment rate in the eurozone, by contrast, fell by only 0.6% over the whole of last year to end it at 11.3%. This brings with it all sorts of other problems, of course, but from an inflationary perspective it leaves a lot of slack in the labour market. It looks likely to be some considerable time before investors need to worry about monetary tightening from the ECB.

On a similar note: with oil and other commodities having fallen or – at best – stabilized in price over the last few months, there is little danger of the weak euro having an inflationary effect. At the same time, the pitch of its descent means it has been winning that notorious game of “beggar my neighbour” for its exporters on the major currency markets. (This is not such great news for some far eastern countries, including China, whose exchange rates have strengthened impressively against the euro.)

There are always risks and Europe faces its own particular demons. But the speed of the turnaround there has been impressive: it was only back in November that the EU Commission last cut its forecast for 2015 growth. Like good news, quick turnarounds might well strike readers as a most un-European phenomenon. It has been most welcome to see the Continent delivering such pleasant surprises for a change.

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