Economic growth in the eurozone region is finally improving, with forecasts from the Organisation of Economic Co-Operation and Development (OECD) predicting GDP growth of roughly 1 per cent for the euro area in 2014.
But while the traditional headwinds of austerity and recession seem to be fading, there are other potential irritations that could upset the current trajectory. Firstly there is the recent ruling by Germany’s Federal Constitutional Court, that the Outright Monetary Transaction (OMT) scheme from the European Central Bank (ECB), may have been outside its remit.
The issue has been referred to the European Court of Justice so the potential impact of this ruling on the recovery has yet to be seen, although it was interesting that on the day the ruling was released European markets dropped initially, but by the end of trading they had recovered to reach new highs.
David Moss, director of European equities at F&C Investments, says: “The OMT hasn’t actually been used; the fact that its there has been reason enough for markets to recover. Secondly the German court has said it ‘may’ be outside its remit. If it turns out that eventually it is not legal, then the ECB has other tools in its locker that can replicate some of the things the OMT is trying to achieve. OMT at the time was a very positive measure, but I think we’ve moved beyond that.”
Instead a potential cause for concern in some areas is the threat of deflation in the area, with OECD figures showing a quarterly consumer price index of just 0.3 per cent in Europe in the final three months of 2013.
Kevin Lilley, manager of the Old Mutual European Equities fund, notes: “The ECB has been very accommodative and I think will continue to be so. The current concerns they are facing are in respect to inflation, or the lack of it. The latest reading was teetering on the edge of potentially moving in to a deflationary area, which is not helpful for anyone.
“So there is a risk Europe is importing deflation. What that might mean is the ECB cuts rates a little further, but they don’t have much ammunition there. The other is some form of quantitative easing, which many think will never happen because Germany is so against it.”
But the manager points out that if more deflationary pressures start to come through, the Bundesbank could relax its stance and allow the ECB “to come up with some more innovative measures to stop Europe drifting into deflation”.
However, there are some bright spots in the region, with the return of Ireland and Portugal to the market, and the light at the end of the tunnel in terms of regulatory pressures on financials.
Mr Moss notes: “There are lots of incremental positives, none are enough on their own to say we can ignore debt levels, but they are better than 12-24 months ago when it was only negatives and only headwinds.”
The more positive environment is benefiting peripheral countries such as Spain, where the market is already pricing in improvements, but also previously unloved sectors such as financials.
“I think there is general acceptance now that we are getting to the end of this regulatory pressure. There will still be bumps on the road but we are seeing some banks starting to lend again and seeing dividends start to be either announced or increased,” explains Mr Moss.
John Bennett, director of European equities at Henderson and manager of the Henderson European Focus investment trust, adds: “While we still believe that many European banks are a terrible investment, there is a huge opportunity for mean reversion. We strongly believe that European markets will not go up this year without banks. They are healing; it is fragile improvement, but there are very interesting things to come from banks.”
Nyree Stewart is features editor at Investment Adviser
