Posts tagged ‘Eurozone’
Tomorrow’s election in the Netherlands may not be very exciting after all. Until recently it looked as though the nationalist PVV would emerge the clear winner, to the extent that keeping its leader from the Prime Ministership would be very difficult. (PVV wishes the Netherlands to leave the European Union among its other policies.) But then the party’s leader, Geert Wilders, was convicted for inciting discrimination before Christmas, and as the campaign got underway the incumbent PM, Mark Rutte, deployed much hard rhetoric and advertising on PVV’s key issue, immigration. The current polling is finely balanced. Mr Rutte has repeatedly ruled out coalition with Mr Wilders. Dutch politics may remain an earthquake-free zone; we will soon know either way.
Eurozone asset markets are priced rather sanguinely in any case. Back in 2011 it was the bond market, and specifically the Italian bond market, which threatened to ignite a wholesale global banking collapse with an internationally unaffordable sovereign default. Back then, the credit default swaps which can be bought to hedge against Italian credit risk cost almost 6% over LIBOR, as against 6bp in mid-2007. Today the rate is 192bp: higher than the pre-credit crunch levels, but then Italy has been downgraded from AA to borderline junk since then. Even the end of the country’s government last December at the hands of a referendum seen as a valve for anti-Establishment sentiment did relatively little to move the price.
Elsewhere in the euro area the story is similar. The exception, which is worth dealing with separately, is Greece. Here the debt burden, which has of course already been restructured once, has reached over 180% of GDP. The IMF – one of the “troika” of creditors dictating Greek fiscal policy – has said that it has again become unsustainable. Fraught negotiations with the Greek government have continued. But none of this is news. Furthermore the Bank of Greece’s November estimate for the country’s budget was of a “primary surplus” (budget balance before debt interest) of +4% of GDP, indicating both a sustainable underlying spending pattern and compliance with creditor demands. There are those who expect the contradiction between monetary union and fiscal autonomy to upend the single currency at some point, but then at the zone-wide level debt to GDP peaked back in 2014 and again, this is hardly news.
Another recent source of concern over Europe was the banking system – or, to be more accurate, the solvency (or otherwise) of various European banks. Deutsche Bank caused consternation for a time, but then the German government has been cutting its debt burden since 2010 and if anyone can afford a major bailout, it is surely them. In any case, no bailout was necessary; DB shares have risen by more than 70% from their lows. Where restructuring has been needed, at Banca Monte dei Paschi di Siena, it has not been anything like sufficiently material to threaten the whole Continent. And where banks are daily dependent on emergency central bank facilities (Athens), this is, once again, not news. Their shares have been available for a handful of cents for years.
There is only one moving part that has shown real signs of weakness: the euro itself. This has fallen by 23% over the last three years. Its low against the dollar of $1.0388 back in December was the weakest level it had reached since the opening sessions of 2003. However, even this is not a credible sign of structural malaise. The currency has been much lower still in the past, hitting an all-time record of $0.8272 in late 2000. And while the ECB has been loosening policy in a range of ways, the Fed has embarked on a tightening cycle. Like the Italian credit spread the euro’s weakness can be interpreted as nothing more than a rational response to changed circumstances.
In other words, there appears to be nothing to see here. Political risk remains, yet seems not to be priced in.
This blog argued at the time that the support of the stronger eurozone economies for the weaker ones in 2010 answered a key existential question for the single currency. In theory, (a) there is no debt mutualisation in Euroland and (b) its members enjoy complete fiscal autonomy. In practice, when the going got tough, there was a very EU-esque “pooling of sovereignty” over debt via the European Financial Stability Facility / European Stability Mechanism. And bailout nations have had to comply with the rules of their emergency lending regimes.
There is another factor to consider, however, and that is Brexit. Attention in the UK tends quite understandably to focus on the consequences for ourselves, but there will also be consequences for the rest of the EU.
A harsh deal, or no deal, with Britain, and some businesses and industries will suffer. It was interesting that a senior executive at global food giant Mars Incorporated spoke about this a few days ago. Agriculture has managed to remain immune to the GATT / WTO decades of compromise on tariff reduction and quota control. Look at the WTO tariff tables and food, drink and tobacco are about the last redoubts of punitive import duties. From the BBC last Friday:
Fiona Dawson . . . said the absence of a deal with EU member states would see tariffs of up to 30% for the industry.
Speaking at the American Chamber of Commerce to the EU, she warned this would “threaten [the] supply chain and the jobs that come with it.”
“The absence of hard borders (in Europe) with all their attendant tariff, customs and non-tariff barriers allows for this integrated supply chain, which helps to keep costs down,” she said. “The return of those barriers would create higher costs which would threaten that supply chain and the jobs that come with it.” Ms Dawson said those costs could not be absorbed by confectionery companies, meaning consumers would have to pay more for their products . . .
Companies in the automotive and the financial sector have been the focus since the vote, according to Ms Dawson. But with food and drink the largest manufacturing sector in the UK, accounting for 16% of turnover, she said she wanted a new focus, and called for EU leaders to look at the bigger picture when negotiating. “There can be no economic advantage either side restricting trade with a large market situated on its doorstep,” she said.
“In simple terms, if the UK and the EU fail to agree on a new preferential deal, it will be to the detriment of all. Other member states should remember this is not about ‘punishing’ Britain for her decision to withdraw, but rather about finding the best solution for European and UK workers and consumers.“
The emphasis at the end there is my own. And it is not just manufacturers who could, in theory, be walloped in this sector. Pity the poor farmers, logistics firms, supermarkets, restaurauteurs who would be crippled by the reimposition of border controls. (The EU’s “Border Inspection Post” system is, to put it mildly, neither rapid nor straightforward. Our own government has helpfully printed the details here.)
A no-deal Brexit, then, would entail potentially disastrous consequences for certain sectors.
This is not priced in. Does this mean that Britain will leave with many of the customs union’s features still in place? That we will, as Ms Dawson clearly desires, not be “punished”?
That is a possibility but it could spell the end of the EU, which appears not to be priced in either . . .
Just imagine. An economically benign Brexit would mean Britain securing a free trade deal that goes way beyond current WTO rules in the key areas of agriculture and fish, while maintaining border control-free access in these and related markets. At the same time we would be regaining complete control of our immigration, lawmaking and judicial processes – and saving part, if not all, of our contributions to the Brussels budget.
A core of true believers – Luxembourg, for instance – might want to stay in the bloc and accelerate the move towards political federation. But surely, plenty of other “member states” would want to follow such an example.
This year’s electoral cycles across the Channel may not threaten the euro, then. But Brexit seemingly has to threaten either some sector-specific but nonetheless material economic damage, or the continued existence, to some extent, of the EU. If a eurozone country wanted to leave the EU, it could in theory continue to use the single currency. But might financial market pricing, by that point, not have begun to look rather different . . ?
So much of the focus has been on Article 50 and the possibility that Brexit might be somehow derailed that thinking has yet to turn to this apparently logical conclusion. The question for investors is: what are the euro assets which are so compellingly attractive that one should wait until it does so?
Think “political risk in Europe” this year and you would most likely have thought about the Brexit vote. It is of course true that Britain faces an uncertain future, and that Brexit will have consequences for the EU too. But it is far from the only game in town.
On Sunday week the electors of Hungary will cast their votes in a referendum on the issue of migrants. Specifically, they are being asked if they accept the EU’s allocation of a migrant quota to Hungary without the consent of their national parliament. The most recent opinion polls suggest that anywhere from three to four percent of citizens are inclined to vote, “yes”. Barring a miracle, Hungary is about to throw down the gauntlet to Brussels in a few days. This has already appalled one or two other EU members: Luxembourg’s most senior diplomat has called for Hungary to be expelled from the Union altogether. In response the Hungarian government is calling for treaty change (specifically reform of the constitutional Treaty of Lisbon).
The question for investors, of course, is: will markets care about this? Even if Hungary were to leave the EU it isn’t in the euro and is a smallish country, so the answer, in isolation, is almost certainly “no”.
It is equally obvious, however, that the Hungarian vote is not an isolated incident. Portugal was talking about a Greek-style referendum on bailout terms over the summer, though this has yet to amount to an actual plan (and didn’t do Greece herself any good in the event either). And next week the Italian cabinet is to fix a date for a referendum on constitutional reform. The detail here is extremely boring but Prime Minister Renzi staked his political future on the outcome. He has tried backsliding on his promise this week but by turning the referendum into an effective vote of confidence in his government it is being seen as a conduit for Italian euroscepticism. This has gained sufficient strength for the Five Star Movement – an anti-establishment party founded by a comedian which sits in the same group as UKIP in the EU parliament – to be leading the polls. “M5S” does not actually want Italy to leave the EU – but it does want a referendum on the euro. In the meantime opinion polling suggests that the constitutional referendum is balanced on a knife edge.
Will rising Italian euroscepticism, or at least anti-euro feeling, present a challenge to the markets’ confidence? Not in isolation perhaps . . .
The Italian situation might well be complicated further should neighbouring Austria elect Norbert Hofer of the Freedom Party to be her president this December. Mr Hofer, who is currently in a dead heat with his Green Party opponent, once called for the border with Italy to be changed and the province of South Tyrol to be incorporated into his own country. Be that as it may he certainly wants to close the Italian border to migrants. And there is more: the last time the Freedom Party came into power (as part of a coalition in 2000) the EU imposed sanctions. Would they do so again?
Looking to the new year, the Netherlands will hold elections in March. There, another party with “freedom” in its name is topping the polls and its leader, Geert Wilders, once banned from entering the UK for his views on Islam, could end up as premier. He and his party want out of the EU.
Soon after the Dutch it is the turn of the French to vote for their president. Marine Le Pen, leader of the National Front, is almost certain to wind up in the second round vote, probably against a centre-right opponent. Like her father in 2002 she will almost certainly go on to lose, but her share of the vote will be interesting. The National Front is, as its name suggests, a nationalist party and has always opposed the existence of the EU.
Then, at around this time next year, we will have the Germans. The migrant crisis has propelled support for a new eurosceptic party, the Alternative for Germany (AfD) to 16% in the polls. It has been winning seats in regional elections. It looks set to establish itself firmly as Germany’s third party come next autumn. Some of its members have an enthusiasm for Nazi memorabilia and have defended some of the actions of Hitler’s government. The party has not yet advocated EU withdrawal, but it was founded to bring back the Deutschmark and stop Germans having to bail out other member states. It is also implacably opposed to immigration, effectively opposed to the idea of the Schengen area and overtly anti-Islamic.
Again, it is possible that the EU and the euro will muddle through all this. France and Germany are not going to elect eurosceptic governments, yet. Wilders’ lead in Holland is not unassailable – and the collaboration of his main opponents could, in theory, keep his party out of power anyway. It is impossible to predict these things but it does seem unlikely that the single currency will be seen to be facing as much of a threat over the next twelve months as it was seen to be facing at the nadir of the sovereign debt crisis in 2011.
The risk, however, is there.
Apart from the voting calendar there are simmering tensions to consider within the EU bloc. Perhaps most serious among these is the stress caused by the migrant crisis. The “Visegrad Group” comprising Czechia, Hungary, Poland and Slovakia submitted a list of
demands proposals at the Bratislava summit last week which included flat opposition to mandatory migrant quotas. The EU is at loggerheads with Hungary and Poland over constitutional issues; meanwhile the Polish and Hungarian leaders are extremely close allies who hold frequent bilateral meetings. This is a barrier to sanctions which some in the EU would like to impose on Poland. (It is seen as a lesser problem that the current Polish government swept to power last year with the first absolute parliamentary majority since the restoration of democracy in 1989.)
Of course there are external issues to consider too, most notably relations with Russia and Turkey. Even more widely, the Brexit vote, support for Donald Trump in the US and the threat of the Philippines to pull out of the UN among other things might suggest that supranationalism as a concept is struggling at this point in history.
But we don’t need to worry about that. There is quite evidently enough within the EU to worry us already.
In isolation, none of these risks appears to pose much of a threat to the bloc or its currency. Importantly, the result of this is that such risks are no longer remotely priced in. Given what we know about the political calendar over the next twelve months it is hard not to conclude that this represents too high a level of complacency.
This week saw headlines appear about the possibility of another debt crisis in Greece. A multi-billion loan repayment to the ECB is due this summer; the European Commission and the IMF – the other two members of the “troika” governing the bailout arrangement – are divided on the scale of deficit reduction required to allow funds to be released; and in the meantime the country has just gone out on a general strike today in protest at any further “austerity”.
It feels, rather sadly, just like old times.
Yet things have changed in Greece since the pandemonium over her original bailout and debt restructuring. The governing leftist coalition, Syriza, has learned through bitter experience that it really does have no option but to comply with its creditors’ requests. And while books will doubtless continue to be written on the fiscal consolidation undergone by western countries since the Great Recession it is undeniable that Greece has been getting on with the job: the budget deficit there, as a proportion of GDP, has been falling from its 2009 peak of -15.2% at almost twice the pace at which it had grown during the course of Greece’s eurozone membership up to that point. This has had the effect of containing the national debt to GDP ratio, which while eye-wateringly high (177% for 2015) has fallen since 2014 despite the suffering brought about as a result of the Greek government’s hubris a year ago. Indeed, take out the effect of the debt restructuring in 2012 and last year’s fall in this ratio was the first since 2007.
There were also tentative signs of recuperation on the broader economic front too. The European Commission’s spring economic forecast was published on Tuesday and the expected contraction in Greek GDP this year was revised down from -0.7% to -0.3%. (Growth of +2.7% is projected for 2017.) The slow turnaround in employment might have halted for now, stuck between 24%-25% over the nine months to January, but with growth beginning to return again this should continue to tick down – and remains below the peak of 28% reached three years ago.
In the meantime, bond markets in Greece and elsewhere on the eurozone periphery are not showing any sign of panic. Ten year Greek government paper is trading down towards its lows for the year to date (just over 8% at present), well short of the over 11% reached during February’s market-wide funk. Italian and Spanish bonds have been priced around the 1.5% mark in recent weeks, just like ten year gilts.
It is worth reflecting that five short years ago – when many respected commentators were confidently predicting the demise of the euro – this was unthinkable. Greece might have been in the headlines again but there is absolutely no contagion in evidence today. Today, markets are not even bothering to try taking on Mr Draghi and his “bazooka”.
It is also worth reflecting that economic growth in the eurozone as a whole is projected at +1.6% this year and +1.7% next – a breakneck pace compared to the average rate of +0.9% over the last 15 years. And talking of headlines, it drew some attention last week when data emerged to show that the zone’s GDP had finally surpassed its pre-Great Recession peak in real terms. Numbers out last month showed its deficit falling as a percentage of GDP for the sixth consecutive year in 2015 to -2.1%, and confirmed that total debt to GDP peaked a year earlier. The unemployment rate might already have dropped back below 10% this month for the first time since April 2011.
There are political risks ahead for Europe but to say that the eurozone as a whole has moved on from the debt crisis is beginning to look like an understatement. It is to be hoped that Greece manages to continue her recuperation. If she does so the “European debt crisis” will soon be history.
Since the summer of 2014 the economic landscape has changed in ways which ought to have brought joy to consumers in various parts of the world. The oil price has collapsed: good news for significant net importers like the USA. There, as in Britain too, job growth has brought the country to near-full employment. In the UK last year we saw positive, sustained growth in real wages for the first time since the Great Recession. In Europe and Japan, which have lagged those other economies in growth terms, central banks have tried to oil the wheels with rate cuts and the expansion of unconventional monetary measures.
Yet this week there were headlines in Britain about the weakness of consumer behaviour. It looked a running certainty earlier this year that the market panic was overdone. But are there signs showing here of strength for the bear case after all?
Looking at the UK first of all: no, not really. Consumer confidence reached 15-year highs last year, and while the survey measure has lost some steam into 2016 it remains above the running average over the year before that. Scrabbling around for negatives, the rate at which new car registrations increased fell to +6.5% in 2015 from +8.6% previously. This is hardly disastrous. And broad retail sales growth across all sectors averaged +4.5%, an 11-year high. The GDP print for Q4 2015 put the annual increase in household expenditure at +2.7%, up a little on 2014 and in line with long run averages. And while readers will know this blog is ambivalent on the subject of housing itself at present, mortgage approvals staged a recovery last year too after falling away in 2014 and that pickup has continued since year end.
The picture is a little cloudier across the Atlantic, but again, far from catastrophic. The personal consumption component of GDP for Q4 grew by +2.7% on the year – also in line with long term averages – though in this instance down from +3.2% in Q4 2014. Retail sales growth has fallen more obviously too, to a 12-month running average of +2.7% to March of this year down from +4.1% across calendar 2014. What is equally interesting, however, is that auto sales over the same period averaged 17.4m, up by a full 1m on 2014 and running at a 15-year high. Existing home sales, too, quickened in pace to the highest level since the credit crunch. Perhaps this is a sign that the net impact on consumption from oil has been disappointing, but that credit expansion has fueled asset purchases instead (a supposition reinforced by a rise in the level of student debt per capita). One can be ambivalent about this again, of course – but it is expansionary economic activity driven by consumer behaviour.
At the other end of the growth spectrum, Japan has had a terrible time of it in recent quarters. At the same time, recovery from yet another period of economic contraction has seen the downturn in household consumption as listed in the GDP figures abate, to a year-on-year pace of -1.3% for Q4 2015 as against -2.0% for Q4 2014. Car sales growth as well as broad retail sales growth has been flat; nationwide housing starts have risen measurably while condominium sales in Tokyo have declined again. So a more mixed picture here, but one which has not been declining any more than it has been showing signs of vibrancy overall.
Finally, Europe has also suffered something of a lost decade, having been through a double-dip recession which the US and UK were spared. Yet here the strength of the consumer has actually been most noticeable. The running 12-month average pace of retail sales growth is stronger now than it has been at any time since 2001. The household consumption component of eurozone GDP rose to an annual +1.7% in 2015 from 0.8% a year earlier, and sits well above the average of +1.1% seen since the zone began life in 2000. Data on building permits and mortgages outstanding show a marked rise over the last year, and passenger car registrations have been rising at a running average of +9.6% over the last twelve months up from +3.5% during 2014. It is most obvious to attribute stronger consumer demand here to cheap energy – as the eurozone is the biggest net oil importer by some distance, this is after all the most obvious place to look. (We should also note, however, that the unemployment rate has begun to fall at a faster pace in recent quarters too.)
For growth investors, growth rates have the constant potential to disappoint. These remain nervous, and volatile times. But if we take a good look at the available data there is nothing to suggest that developed-world consumption has done anything more than fail to respond to the theoretically benign tailwinds of cheap oil and monetary expansion in the way that some might have hoped. This is not the same thing as failing to respond at all.
The continued negotiations over emergency lending to Greece have been an obvious political risk for some time, and one which increased with the change of government there in January. This week’s leading stories have been dominated by the latest down-to-the-wire developments. The shock deferral of a payment due to the IMF until the end of the month was followed by recriminations between the Greek government and its creditors at the highest political level and the IMF team itself has now stormed off from Brussels in despair: EU Prepares For Worst As Greece Drives Finances To Brink (Bloomberg)
We have already looked at the possible consequences, and certain pain, that would ensue following a Greek sovereign default (The Joy Of Negotiating). In any case an indebted Greece would still require emergency funding of some kind in the aftermath of such a default as the bond market would be closed. Its emergency creditors would likely be exactly the same bunch it is dealing with today, or wild card lenders like Russia or China who on the evidence of previous discussions would require security over the nation’s land or other assets that even Greece’s previous government was unwilling to consider.
The Greek public appears to be more alive to the reality of their situation than their government. According to a poll conducted at the beginning of the month, 47 percent disapprove of its brinkmanship (and 74 percent want Greece to remain in the euro).
Even as time truly begins to run out, however, markets are still relatively sanguine about the possibility of default. Peripheral country bond spreads to Germany have widened a bit but remain below levels reached last summer, before Greece resurfaced as an issue. The euro is 3% up on the month to date. Equity markets have shown some nerves but there have been absolutely no signs of panic in the pricing of haven assets such as US Treasuries or gold. This is nothing more than reasonable: Greece is a small economy (GDP of $242bn in 2013 on World Bank numbers, less than 2% of the eurozone total), so the level of contagion occurring naturally from its collapse would be relatively muted.
Which brings us on to the real tragedy of these negotiations: the effect they are having on Greece. Economic sentiment has withered back towards the level it occupied during the final quarters of the country’s last recession in 2013. The banking system has been weakened – again – by the offshoring of deposits. Another recession is guaranteed. This is doubly disastrous when one considers that the budget deficit last year, at €6.4bn, was its lowest since 2000 and down from a peak of €36.2b in 2009. The country had exited recession, was running a primary surplus, meeting its debt obligations and seeing the number of unemployed decline for the first time since 2008. That has all been thrown away. Only yesterday employment data showed that the economy has gone back to shedding jobs. And in a year when European growth and consumer spending have been picking up notably and the currency is internationally weak, Greece’s key tourism industry might well have been expected to put on its strongest showing since the financial crisis. It would be astounding if the heightened uncertainty and bad press arising from the government’s actions have not turned many of those tourists away now.
The bottom line is that Greece needs its credit lines more than its creditors need to spend time playing games with the Greek government. The question the members of that government ought to be asking themselves, again and again, is: who benefits?
Let us leave the last word to an economist quoted in this post’s first linked article:
“People are really fed up with this,” UniCredit SpA Chief Global Economist Erik Nielsen said in a television interview. “They’ve never seen anything so completely ridiculous, frankly speaking, from a debtor country.”
The FTSE 100 index hit a new high only a few days ago, closing above 7100 for the first time on Monday. Risk assets have generally had a strong year. There has not even been any visible excitement over the prospect of a secessionist wipeout in Scotland or any of the other shocks which have been postulated by Westminster pundits in the run up to the election next week. But tensions rose yesterday when the US GDP print for Q1 came out almost flat against expectations for a lacklustre but positive +1%. Markets took the number badly. Was it a sign that the global economic motor is slowing – yet again? Has the pricing of risk got ahead of itself?
There have undeniably been signs of pressure on the US. One agent of the weak growth number was a decline in net exports: by the end of March the dollar had strengthened by more than 20% on a trade weighted basis over a period of nine months. Currency strength was expected to weigh on corporate earnings too. As earnings season opened earlier in the month forecasts were for a 6% drop in EPS for the S&P 500 index relative to Q1 2014. And it is not just the US of course. China has come under scrutiny for growth outcomes well below the 9% averaged by the economy over the past 20 years. Towards the middle of the month data for retail sales and industrial production disappointed the market consensus, and there are signs that the manufacturing sector has fallen back into slight contraction.
After the run markets have had so far and the experience of most of the last few years it is perhaps natural to expect a period of retrenchment, if not a modest sell off, over the next little while. If the economy is indeed under pressure then this could catalyse such an event as well as justifying it. The picture is more mixed than it might appear, however. From the US we had stronger than anticipated employment data out only this afternoon, with initial jobless claims down to 262,000 – within reach of the previous low of 259,000 recorded in April 2000. And corporate earnings have not collapsed as feared: with two thirds of the index’s members now having reported, S&P 500 EPS are up by 3% over the previous year and the forecast for the whole index this season has come up to -1%. In China too, foreign investment growth has continued its solid run, service sector activity has accelerated and some progress has been made on structural reform (an area which is often overlooked).
Furthermore, the world’s glass is half full as well as half empty. Given the size of its markets, power of its central bank and global economic influence it is inevitable that the US should occupy much of our thoughts. While the titan across the Atlantic has been struggling a little, however, the weary colossus of Europe has begun to show improving signs of life. Similarly, while the growth rate of the world’s most populous country has fallen back it has been overtaken by stronger than expected economic expansion in the second most populous: India, where GDP growth for 2015 was projected to reach 5.5% at the beginning of the year is now forecast to see 7.4% (using Bloomberg consensus data). This speaks to the continued variability of outcomes identified as a market theme by this blog for the current calendar year, and it should also make us wary of interpreting particular data as evidence of general gloom.
Before leaving the subject of growth behind it is worth looking at the behaviour of the oil price over recent weeks. The collapse in crude was the most significant market event of the last few months of 2014. It generated pronounced volatility in equity markets and its disinflationary impact thrust bond markets higher – especially in Europe, where yields have reached record lows. The price stabilized over Q1 (a cornerstone of the rallies we have seen). Indeed it now appears to have bottomed, with both the Brent and West Texas Intermediate futures contracts up over 20% this month. This has had effects which few might have predicted back in December, such as helping the Russian stock market become one of the world’s top performers over the year to date.
It also means a bottom for oil-driven disinflation, though it is likely to be a few months before this washes through to annual CPI numbers. At the same time, that US labour market data reminds us that underlying pricing pressures will have been gathering strength. Only this morning the Employment Cost Index rose by its highest annual rate – 2.6% – since 2008. Looking forward, it is perhaps here that we might find genuine reason for concern on the macro front, and another source of variability between markets as the year plays out.
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.