The recent election results in some European Union countries have been a balm for markets and investors. The elections in the Netherlands and Austria, which managed to banish the far right; the presidential elections in France, where Macron managed to prevail over Le Pen; and the recent results in German Länder (federal states) which consolidated the power of Angela Merkel’s Christian Democrats (CDU), are all examples of how some of the risks to the eurozone have dissipated.
The fact that anti-European parties have not taken power, although they are present in some municipalities or regional governments, is reassuring the markets, particularly North American investors. It has been shown that, for the time being, the contagious effect of Brexit has been neutralised in continental Europe and that the most immediate concerns have focused on global issues such as the oil price, the Middle East and the diplomatic crisis in Qatar. In this regard, it should be noted that the terrorist attacks against European cities and interests have had no impact on the markets, indicating that investors have confidence in the ability of governments to deal with these problems.
From an economic point of view and a market perspective, the current situation in the European Union can be deemed to be positive. The eurozone’s large economies are bolstering their growth, despite the fact that purchasing managers’ indices have fallen slightly. Accordingly, we have revised up our forecasts and now expect the eurozone economy to grow at a rate of 2% in 2017 and close to 2% in 2018, thanks to broader recovery across eurozone members and firmer trends in core countries.
Given the favourable monetary policies, it is advisable to maintain investment and remain overweight in equities, in particular in European equities. In any case, the European Central Bank should maintain its accommodative policy in the short term, but it will make gradual changes in its communications in an effort to prepare the markets for a less aggressive policy next year. This will have a significant impact on the European bond markets, as yields remain low in relation to the economic trend. More precisely, there is not so much value in European government bonds, especially German Bunds.
Moreover, given the rising yields, relevant structural reforms are keys to avoid upwards medium-term pressures on peripheral spreads and to keep economies on a positive trajectory: as far as this is concerned, Italy has not made sufficient reforms, as Spain did in due course, and the challenge for France to take decisive reforms to revive its past moderate growth performance is huge.
Spain presents a different case. Its situation in terms of debt is somehow more comfortable than the Italian one, as the government undertook a package of tough structural measures that helped to redress the serious economic crisis that began in 2008. We estimate that the economy will grow at close to 3% in 2017 but we also think that there will be a slowdown in growth due to the maturity of this economic cycle. Despite this, there are good trends in terms of investment and domestic consumption (contrary to what is happening in the UK), and Spain has managed to gain export market share both inside and outside the European Union, which is a difficult task considering the high value of the euro. At the same time, unemployment has been decreasing steadily.
In general we believe that now is a positive moment for the Spanish economy, but the government must be aware of budgetary imbalances, which are a traditional source of conflict with Brussels. The growth of the economy and exports, reduced spending on unemployment benefits, and macroeconomic policies are all good indicators that should also help to halt the growth of public debt in relation to GDP.
European countries are at a crossroads where security problems stemming from recent terrorist attacks have shifted the debate. Europe is accustomed to dealing with these types of issues and it is true that it has always emerged victorious, which is reassuring both markets and investors. A renewed European project is now the other major challenge that could push eurozone growth on a higher trajectory and see politics less dependent on the rest of the world. Old Europe is launching a new Europe.
Chief Economist, Global Head of Economic & Thematic Research