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In the second of a two-part analysis, City Insider David Stevenson considers the economic outlook for Europe and the impact of a UK General Election
Read the first part of the analysis here
Everyone and their dog reckons the European Central Bank is about to unleash monetary shock and awe i.e. quantitative easing based on the US and UK experience.
I don’t doubt that something needs to be done to combat the deflationary pressures rippling through Europe, especially as Greece looks like it is wobbling. But my suspicion is that investors will be disappointed with what comes – more intervention yes; full-blown QE, probably not.
What will happen regardless is that the euro will continue to weaken – which will help the zone’s exporters – and we’ll see compelling evidence of more buoyant corporate profitability especially in the core German market.
German businesses already have an exemplary record of delivering near-7% annual growth in average earnings over the past 20 years and when the rebound comes we’ll see it from a long way away.
This slowly improving economic story in Germany and Northern Europe (helped by weak oil prices and steady growth from emerging markets) will probably encourage the European Central Bank to avoid pressing the QE button.
It should also spell good news for Tui and Thomas Cook in their core German, Swedish and Dutch markets.
The only obvious worry remains France which looks vulnerable to political turmoil even though its Socialist government is actually making sold progress in structural reform.
It’s also worth observing that the euro austerity story isn’t necessarily the full picture. Looking at the year-on-year numbers, GDP growth in at least another four eurozone countries was above 3% last year (Malta, Ireland, Luxembourg and Slovenia) and a further five turned in growth above 1.5%.
Sticking with the European theme, the UK could be the surprise story of the year.
Again this will be a study in contrasts. On one level, consumer demand is resurgent. Analysts at investment bank Morgan Stanley recently observed that a widely watched indicator from Asda showed consumers are as optimistic as they’ve been in recent years.
The consumer sector will also benefit from two additional drivers – the declining oil price will help boost real incomes and pension reforms will release countless billions into the real economy from locked up savings plans.
Even our export sector might begin to feel some benefit from the slow turnaround in the eurozone and a continued recovery in the US.
The downside is all too obvious – the imminent UK general election. An inconclusive election result is nigh on certain, with all sorts of political jiggery-pokery along the way.
Investors will run scared of this uncertainty (some estimates put the losses in GDP growth from uncertainty around Scotland’s referendum vote last September at close to 0.5%).
The much bigger worry is that there could be a second general election quite soon afterward, followed swiftly by a highly destabilising referendum vote on Europe.
Whatever view you may hold in this debate, the uncertainty about the UK’s role will put off many foreign businesses from investing in the UK.
UK stock markets may wobble in 2015 and we could see sterling’s recent strength reversed, especially against the euro.
But the biggest surprise could be towards the end of the year. Many investors have begun to accept that the US Federal Reserve wants to stop Quantitative Easing and increase interest rates.
Similar sentiments are echoed in the UK where the Bank of England is running a fairly tight liquidity regime already. The problem is that the global recovery isn’t quite strong enough to withstand the panic and turbulence which will result.
Yes, the US is growing and yes the eurozone might pick up. But growth in both is still well below long-term trends. China is also making difficult adjustments and Japan is still in deep trouble, locked in an icy deflationary embrace.
It all means the global recovery is vulnerable to sudden changes in sentiment.
My money is on a determined attempt to stop QE and increase rates late in 2015 and 2016. Markets and investors will panic, thinking a recession is coming and we’ll see QE restarted again – QE Mark 4.
That will hit the dollar hard. Interest rates will stop rising and then start falling again and investors will calm down.
Yet the big structural problems affecting the global economy (ageing societies, weak consumer demand, indebted emerging economies) have not been solved.
So if I’m right and QE does make a comeback, we can bet on a number of outcomes. Oil prices will start to rise again as everyone anticipates one last push to build a sustainable recovery.
House prices will also start to increase again as interest rates head lower, which will in turn boost consumers’ perceived wealth (an illusion, of course, but hey who cares).
Sterling and the dollar will both start to fall back (if the US has to deploy QE4 you can bet the Bank of England will have to follow) and the eurozone should finally be able to lift itself out of its funk.