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New Year, new concerns

Mike Keogh

Michael Keogh, Associate Director of Research & Strategy, discusses early developments in the European economy since the start of 2015.

Our research team would rather not start the year with a note highlighting what has proven to be quite an ‘interesting’ 2015 already, but it is hard to ignore the imminent ‘snap election’ in Greece, the recent currency swings, plus oil’s retreat and the likely effects that European QE has on financial markets.

Let’s start with oil. The collapse in oil prices witnessed over the last six months has shocked many, with brokers now projecting pricing to remain historically low in 2015.  Whether it is a reflection of weakened global demand, alternative sources of energy, continued over-production or a factor of political forces at work, the initial boost to debt-laden consumers in the West- at a time of public sector de-leveraging- should boost output and lower input costs for businesses; although the impact on certain oil-based economies looks less certain. A lower oil price acts like a much-needed tax cut for consumers whose purchasing power increases. Assuming the benefits do not lead to a marked rise in the savings rate, the IMF have stated that the traditional transfer mechanism from lower costs to increased spending could boost global growth by 0.7% and 0.6%, in 2015 and 2016, respectively. Ultimately, the initial market impact will be a drag on inflation, a weak euro supporting exporters, and a very shallow bond and borrowing rate curve, which reiterates our opinion that interest rates are unlikely to rise in Europe until 2017 at the earliest. From a real estate perspective, the sector’s relative pricing will continue to win admirers. But a prolonged period of lower energy or commodity prices can raise questions over the longevity of sovereign wealth or private money into certain property markets, and ultimately, liquidity and pricing volatility.

Turning to the QE or not to QE debate relates to a lack of growth and deflationary fears in Europe, with markets being sustained by an expectation of ECB action to ‘do whatever it takes’ to stimulate expansion. Downgrades to growth assumptions and the scale of the oil price fall is, without a notable rise in household spending or exports linked to a weak euro, likely to drag Europe into deflation in the early stages of 2015. This will be related more to oil than a generalised decline in either wages or prices. Consensus recorded a Eurozone CPI of 0.4% in 2014, and its January 2015 edition implies a figure of just 0.1% in 2015, with Germany at 0.7% versus Spain at -0.3%. As such, the aggregate number will continue to mask the fact that a number of peripheral economies will continue to suffer deflation, highlighting the difficult challenge the ECB have in the future in an attempt to ‘normalise’ market conditions. Draghi has recently given his strongest signal yet, that the central bank would extend its asset purchases to include sovereign debt. Initially, this would provide a boost to financial markets, spending, help fight the threat of deflation and lower yields on debt issued by weaker governments. But there is the debate that it is not the cost of finance, but the lack of demand that is the issue. Without market confidence, without businesses beginning to invest, in part linked to political uncertainty, QE will help fuel asset prices, but it is questionable whether it would really change projections of low growth and benign inflation. Recent years have showed that without reform, monetary stimulus can provide only limited progress. A realisation that there is limited appetite- given German opposition- or ability for action, plus questionable intent to reduce deficits or enact structural reforms, only hampers Europe’s growth agenda. History states it takes a good 12 months before growth really improves after an oil price slump. That will prove a welcome bonus but it should not be forgotten that low inflation also means government debt burdens are not eroded as much, which may cause potential hits to certain bond markets.


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Michael Keogh

Mike Keogh

Director of Research

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