European Economic Update – 11 August 2014

Italy slips back into recession on competitiveness problems; European markets fall

European markets fell over the course of last week as the US ordered air strikes against insurgents in Iraq and the Russian government responded to international sanctions by imposing a blanket ban on the importation of certain foods from a range of countries.

In addition to heightened geopolitical tensions, economic data for the week also appeared to point toward a further slowdown in the continental recovery.

This was as growth in German industrial production came in at 0.3% VS a forecast of 1.7% for the month of June, while French unemployment also rose moderately during the same month. In Southern Europe, GDP data for Italy revealed that the nation slid back into recession during the second quarter.

In relation to monetary policy, the ECB announced no further stimulus measures. Instead, the Governing Council opted for the wait and see approach given that the full extent of the ECB’s June measures are yet to take effect.

In short, events in Europe over the last week continue to point toward an uneven recovery, with challenges facing both peripheral as well as core economies.


Spanish economy outperforms on the periphery

On a more positive note, the Spanish economy continues to turn a corner. While the fall in unemployment claims for the month of July was less than expected, the economy grew at its strongest pace for six years during the second quarter.

In addition to this, overall unemployment in Spain continues to decline, which when combined with low inflation, is supportive of further gains in consumer and business confidence.

As a result, there is now a consensus among financial analyst that Spain could be about to enter a “virtuous” and self perpetuating cycle where low inflation and falling unemployment support growing confidence and greater investment from the private sector, which is in turn supportive of continued growth.  


EU recovery is lacklustre, but alive

Looking forward, German and EU bloc wide GDP figures are due over the course of the current week, both of which are expected to add further confirmation to notion that the continental recovery remains uneven.

While the bloc wide measure of GDP is expected to indicate positive growth of 0.1% for the second quarter, official forecasts imply a contraction in the German economy during the same period. In addition to weaker German data, French GDP and Payrolls numbers are also expected this week.

While forecasts from the national authorities are largely positive for both measures, the French economy has consistently underperformed against expectations this year. Consequently, a further deterioration cannot be completely ruled out.


The takeaway

In summary, and on the basis of official forecasts; the outlook for European economic data is less than positive for this week. We believe that if official projections are correct, then the week’s data will underline the true extent of the challenges which the ECB faces over the months ahead, and should go some way toward heightening expectations that the ECB unveils further stimulus measures before the year is out.

From an investment perspective, the current environment is still very favourable for European equities. While we see rising geopolitical risks and economic sanctions as a threat to portfolio returns over the near – medium term, these risks are balanced against the likelihood of further stimulus from the ECB during the months ahead.  

In addition to this, we see a stabilising Chinese economy, strong recoveries in the US & UK as well as a weaker euro each as holding positive connotations for corporate earnings in Europe.

Consequently, our baseline viewpoint that European equities are attractive, from a valuation and earnings momentum perspective, remains in place and unchanged.

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