Europe March review: the month began with talk of monetary policy tightening and a tapering of the ECB’s expansive quantitative easing strategy, given a long-awaited uptick in inflation. Goldman Sachs forecasted a 1.9% growth in eurozone inflation in February, with energy being the largest contributor, while PPI grew at its fastest rate since January 2013, reaching 3.5%.
In the French presidential election, the first poll emerged showing that Macron would defeat Le Pen in the first round, as Fillon continued with his embattled campaign, breaking a pledge to quit if he was placed under formal investigation. In fact, other scandals also began to surface. Polls also suggested, however, that those who are most likely to vote Macron in the first round are also most likely to change their vote in the second, meaning that the race to find Hollande’s successor is far from over.
France’s first televised debate of its kind saw a strong performance from front-runner Macron which helped solidify his lead in the polls, while left-wing Jean-Luc Mélenchon also put in a noticeable display.
The minutes of the monetary policy committee meeting also suggested that ongoing political uncertainty is the biggest risk to the eurozone this year. Some of this risk was alleviated as incumbent Prime Minister Mark Rutte’s party, the People’s Party for Freedom and Democracy, beat polling expectations to win 33 seats in the Dutch general election on March 15th, the first hurdle in what was seen as the assessment of populism rising in Europe’s largest economies.
The euro strengthened as a result, although stability in the Netherlands is not yet assured as, with every general election since the Second World War, a coalition government will need to be formed. In the past, this process lasted an average of 80-90 days, although one certainty is that Wilder’s Freedom Party will be excluded from these coalition talks after finishing a distant second, with 20 seats.
On March 26th, Merkel’s CDU party extended their vote share in the tiny region of Saarland, with populists AFD only receiving 6% of the total ballots cast. Despite only being a small representation of the electorate, many analysts see this as a barometer for the wider public opinion of Merkel’s popularity in the build up to federal election on September 24th.
Bulgaria’s centre-right party The Citizens for European Development, led by former Prime Minister Boyko Boris, won a legislative election, defeating the socialist party who had campaigned for the EU to drop Russian sanctions and supported a pipeline that would increase Russia’s oil imports into Europe.
The Hard Figures
In the UK, manufacturing and service sector surveys both missed analyst expectations, which brought the pound to its sixth consecutive losing day.
The first full trading week saw the official release of the eurozone Q4 2016 growth figures, showing a rise of 0.4%, as expected. 0.2% of this growth was driven by household consumption. Eurozone imports outpaced exports, further increasing the trade deficit.
German industrial orders declined by 7.4%, the worst figure since 2009 and twice as bad as expected.
Central Banks Reacting
Perhaps these numbers were enough to frighten Mario Draghi, the ECB’s chief, as he announced that QE and the current deposit rate of -0.4% would both be maintained.
Central bank activity resulted in interest rates being held in Norway, England and Switzerland. The latter expressed concerns over the strength of its currency, the franc, often seen as a safe haven asset due to its high current account surplus that protects its value from external headwinds.
The pound strengthened as policymaker Forbes voted for a hike as inflation overshot the Bank of England’s target of 2%, registering at 2.3%. This is the first time in three years that inflation has exceeded the target value.
Charlotte Hogg, the former Chief Operating Officer and Deputy Governor, resigned her post after disclosing a conflict of interest involving her brother who holds a senior position at Barclays. The Bank of England also unveiled its 2017 stress test criteria, with the results due to be published in Q4.
These tests involve a number of different scenarios, from a -4.7% hit to GDP, a 33% decline in property prices and a 4% interest rate, to prolonged low-interest rates and weak growth. The tests, which are the toughest ever implemented by the bank, are looking to continue to bolster the banking sector in preparation for Britain’s departure from the European Union, cited by the monetary policy committee this month as the biggest risk to the economy. Returning to the continent, the ECB announced the conclusion of the ‘Targeted Longer-Term Refinancing Operation’ which provided banks with a four-year loan at 0% interest.
A waiving of the lengthy examination process for investment/retail banks financial models was also confirmed, in an attempt to lure business away from the City of London. A merger deal worth $14bn between the Deutsche Börse and the London Stock Exchange Group was blocked by the EU, over concerns that the deal could create a ‘de facto monopoly’. There is no doubt that Brexit also played a part in this decision, as the combination of the two largest exchanges in Europe would have created headquarters outside of the EU27.
Brexit Weighing in
Speaking of Britain’s departure from the European Union, the second half of March witnessed a flurry of activity that is historically significant but caused no noticeable movement in the markets. The date for the triggering of Article 50, the official notice that a member state will leave the EU, was confirmed as being March 29th, after the House of Commons rejected the House of Lords’ amendment to the bill that would have forced the UK government to guarantee the interests of European citizens living in the UK.
A terrorist attack on Westminster resulted in the death of four innocent people. This act has prompted a review to explore how to protect citizens in crowded public areas, in addition to how much privacy/encryption should exist.
Nicola Sturgeon announced a bid for a second Scottish independence referendum, and an official request to do so cleared the Scottish Parliament with support from the Green Party. Polls suggest that the Scots do not have the appetite for this, although support for independence is at a higher level that it was when the first independence referendum was legislated for in 2012. Article 50 was triggered, eight months after the initial vote, and now the direction of the UK financial markets and currency value will be dictated by these negotiations, as well as any signs that the UK economy is starting to feel ‘Brexit-related cracks’.
A report from Citi predicted the FTSE 100 hitting 8000 in mid-2018, while Blackrock is long the pound. Despite these bullish endorsements, MSCI UK’s relative performance to MSCI World is at the lowest level since 1976 in dollar terms. International investors who own commercial real estate have also seen the largest depreciation of capital value in dollar terms since 2008, the third-greatest drop on record.
The Bigger Picture
Since January 2016, total fund outflows per month in Europe have matched the same figure seen during the financial crisis as a percentage of total assets under management, despite performance versus global equity. Earnings growth has remained relatively unmoved along with an improving macro situation, hence the risk premium is primarily a reflection of the political risks with the approach the French and German elections.
The month concluded with some strong soft data: the IHS Markit’s Purchasing Managers Index measuring Euro area PMI rose to 56.7 in March, beating expectations of 55.8 to reach the highest level in six years. Hiring picked up in the manufacturing and services sectors, helping eurozone unemployment to drop to 9.5%, its lowest level since May 2009.
German business confidence registered at the strongest level since 2011, beating expectations. Imports came in at 7.4% versus 7% expected, while unemployment in the region’s largest economy is at a record low of 5.8%.
Italy’s manufacturing sector confidence reached the highest level in a decade (107.1 versus 106 expected). Hard data out of the UK showed a revision of Q4 2016 GDP, for which the weaker pound helped boost trade, as consumer spending was impacted; consumer confidence is now lower than before the EU referendum vote according to Lloyds Banking Group. The hard data, however, showed retail sales strengthen after rising 3.7% compared to February 2016 and up 1.4% versus January 2017, beating expectations and giving a boost to the value of the pound.
Greece consumer sentiment trended downwards as the country is once again locked in debt relief talks, while Fitch upgraded the forecast for Polish economic growth leading to a rally of the zloty.
However, Ireland’s retail sales growth fell to the lowest level since 2013.
In the month ahead, all eyes will be on the improving macro data in Europe, continued Brexit negotiations as the final guidelines for the negotiations issues by the European Council are published on April 29th, as well as the first round of voting in the French election.