The outlook for European growth is good. Fuelled by expansionary conditions and in particular a weak...
The outlook for European growth is good. Fuelled by expansionary conditions and in particular a weak currency, growth is accelerating and should comfortably exceed 3% this year and next. Although a lot of attention has been given to rising interest rates, the increases so far have not compensated for the effects of the euro's decline, conditions are therefore as stimulative as they have been for a decade. As a result money supply growth rates are accelerating, up to 6.5% in April versus a 4.5% target. This means that interest rates will rise. However, the broad aim of the ECB is neutrality. It does not seek to put a foot on the economic brake, but rather to take it off the accelerator. At current growth rates the output gap will close towards the end of this year at a time when output is still strong.
Inflation has been a positive and core rates of around 1% and wage growth held to 3% are encouraging. Unemployment is a factor, sticky at 10% for the region as a whole but worse in Italy (11%) and Spain (15%). Overall we expect a couple of rate increases before the summer recess in August but beyond that there is no compelling need for further action.
The euro is bottoming out relative to the dollar and may have already seen the low point against sterling. Looking to the medium term we expect a recovery from very cheap levels. There is a good relationship between the exchange rate and relative GNP growth rate expectations and while Europe seems set fair, the leading indicators from the US are increasingly mixed and recent Fed action suggests a firmer policy stance from them over the next few months to slow expansion rates.
The bond picture is complicated by the different trends in government and credit markets. Both are subject to special factors at present but overall our view is that it is the corporate area, where yields have been rising, that gives the truer picture. Rising yields are clearly a challenge to equity valuations and one which we expect to remain in place near term, easing later in the year as the euro rallies and the rate cycles in the US and UK near maturity.
So where does all this leave our view of European markets? We remain bullish and continue to rank Europe at the top of our list of preferred markets. Earnings growth this year will be in the high teens as some companies chose to use currency weakness to build margins rather than market share. These growth rates owe much more to the cycle than structural change. Further support will come from corporate restructuring.
We are overweight in the Netherlands, Belgium and Finland. France is held slightly below benchmark but we are more negative on Germany.
European fundamentals are attractive and as conditions normalise European markets will show relative strength.
European Investment Team at Barclays Global Investors
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