EU Economic Update – 08 December 2014
EU economic data continues to disappoint
While European equity markets rose broadly last week, supported by stronger US economic data and a dovish ECB, economic data emerging from continent continued to surprise on the downside.
Of particular concern were manufacturing numbers from Italy which confirmed a continuation of recessionary conditions in the one of the nation’s key industries. The persistent weakness in Italian economic data led Standard and Poor’s to cut the nation’s sovereign credit rating to BBB- on Friday, leaving it just a short single step above junk status.
While the revised rating is assigned a stable outlook the agency cited that this was reliant upon the government persisting with structural reform and austerity measures, as well as an exit from recession in early 2015.
While it remains too early to rule out some form of recovery for the Italian economy, the risks facing it have certainly increased in recent days. Should its rating be cut further to junk status, and this situation be replicated by any of the other leading agencies; Italian debt markets and the Italian economy would encounter some considerable pressure.
Political risks are on the rise
Despite the ratings action above, it was not just economic data that put peripheral Europe back into the headlines this week and last, as anti-austerity protests across the southern sphere also made headlines.
Riots were reported in both Italy and Greece, where anti-EU and anti-austerity political parties have been gaining widespread support throughout recent quarters.
In Milan, annual protests at the La Scala Opera house saw both police and protester casualties admitted to hospital, while fires burned in the street long into the night.
This followed days of violent protests in Athens where demonstrators took to the streets in order to oppose the government’s budget proposals for 2015.
Although public demonstrations in peripheral Europe are certainly not a new thing, these most recent events cast fresh light upon what we believe is one of a number of prominent risks facing UK and European investors as we head into 2015.
Despite that the persistent decline of inflation does pose an economic risk, given that the impact of this will only be felt over time, we feel the issue likely to have a more immediate effect is the rising risk to European “unity”, or the union its very self.
This is as all across Europe, in almost every direction, anti-EU, anti-austerity and anti-immigration parties have been rising rapidly in popularity throughout 2013 & 2014.
This has been, among other things, in the wake of a persistent failure by the bloc’s politicians & institutions to address public concerns over a range of issues, as well as the deep flaws within the structural design of the project itself ( i.e fiscal union & political process).
The above trends are legitimised as threats to both markets as well as the union by the prominence of
the France’s Front National, the UK’s UK Independence Party, Italy’s Five Star Movement, and also by similar parties in Greece, Spain and Germany. In each major economic limb of the bloc, resides a right wing political party rising to prominence in the face of continent’s economic and political woes.
Now with a late entrance to the party from the ECB, uncertainties still remaining over the likely effectiveness of any eventual QE program and a continued stiff German resistance to any meaningful form of fiscal stimulus; we see a high risk that a spate of national and local elections could see investors spending a reasonable portion of 2015 becoming acquainted with new acronyms.
Such acronyms would be equivalent to Brexit and Grexit, reflecting rising demand for an alternative economic and political future in many corners of the union.
This will of course pose a challenge for investors as both bond and equity markets are unlikely to welcome any form of conversation that seeks to debate the merits of continued membership against any form of exit.
Mario Draghi and the governing council remain in the spotlight
Draghi announced lower growth and inflation expectations at ECB press conference on Thursday before reiterating the likelihood of further stimulus to come should the current measures prove ineffective.
There is now an almost unanimous consensus, on the likelihood of further easing, among the analyst community
While the majority appear to favour the January or Feb meeting, we are slightly behind consensus in that we believe a final push to act is more likely in the Feb or March meeting.
This is largely because we anticipate a minor bounce in December inflation numbers, due in January, and for a similar decline in the unemployment rate to occur as a result of seasonal factors.
Given the magnitude of an ECB decision to purchase sovereign bonds, and the likely resistance from German policy makers and the public, we expect that the governing council will be unwilling to act without the full support of the most current economic numbers.
As a result, should we see any form of increase in inflation at the January release and the seasonal reduction in unemployment, we would expect the ECB to hold fire until economic data confirms that the adverse trend has continued.
Nevertheless, investors appear to view an all out quantitative easing program from the ECB as a portfolio positive event at present and for this reason, we see scope for such expectations to support continental equity markets into the new year.
EU INDICES // 10 Minute Intervals – (DAX, Black), (CAC40, Red), (IBEX 35, Blue)
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