Robert Lind is a European economist with 30 years of industry experience. In this interview, Robert offers his increasingly optimistic view on the economic prospects for the euro zone, interest rates and European markets over the next 12 to 18 months.
Q: What’s your outlook for the European economy?
A: We are starting to see a very significant pickup in European economic activity and I think it’s only partially being recognized by investors. Over the past few months, some extraordinary macroeconomic indicators have emerged and they’ve surprised just about everyone, including me.
The manufacturing activity (PMI) numbers that were released at the beginning of January are simply off the scale, as far as Germany and the euro-zone aggregate are concerned. They are now at their highest levels on record. In addition, the latest economic sentiment indicators – which combine manufacturing, retail, services and consumer confidence into a single confidence measurement – are now close to the cyclical highs that we saw in the mid-2000s.
This encouraging data, along with a few other key indicators, have led me to believe that the consensus view on Europe — that growth is about to roll over — could well be wrong this year, just as it has been wrong over the past couple of years. It’s entirely possible that we could see another surprise in 2018 and euro-zone growth may be much stronger for longer. For instance, in my view, euro-zone GDP growth could be close to an annualized 3% rate in the first half of 2018.
Q: What are some of the underlying trends characterizing this growth surge?
A: What’s really striking about it is the breadth of the upturn. The German economy has long been the strongest in Europe. But the countries that were previously lagging behind — principally France and Italy — have experienced dramatic changes in their economic environments over the course of the past year.
The biggest and most encouraging change is actually in France, where the economy has suddenly turned from stagnation to boom just in the past year. That’s presumably coming on the heels of a rise in animal spirits following the election of President Emmanuel Macron, a centrist, pro–European Union leader who pledged to bring economic and political reforms to France. So far, Macron has implemented some important changes, and businesses and consumers are responding positively.
Q: Do you think this recovery is sustainable?
A: It is worth noting that Europe’s past recoveries have typically been driven by net export activity, which means it’s been vulnerable to demand disappointment in the rest of the world. This recovery, however, is being driven by rising exports as well as impressive increases in domestic demand. Alongside stronger consumption, there has also been a significant upturn in investment spending, particularly by businesses. That has always been the missing ingredient in Europe and it’s one of the important reasons why I believe this recovery can ultimately be more self-sustaining going forward.
Q: What’s the outlook for euro-zone inflation and wage growth?
A: Inflationary pressures in the euro zone remain muted. Core consumer price inflation is still below 1% on an annualized basis, which is about half the target rate of the European Central Bank (ECB). We are beginning to see the very first signs of wage pressures picking up. However, keep in mind that wage growth has been extremely weak in most parts of Europe for a long time, so the slight increases we are seeing now in France, Italy and Spain are very modest and not what you would hope to see at a time when economic growth is improving so dramatically. That means the official ECB forecast of a very slow and gradual rise in core CPI is the most likely outcome over the next year or so.
Q. How does that view shape your expectations for European interest rates?
A: One of the main reasons that interest rates in Europe, and globally, remain very low is that the ECB is still engaged in an aggressive strategy of quantitative easing. Policy rates are in negative territory and the ECB has extended its €30 billion-a-month bond-buying program through at least September 2018. That means the first opportunity to raise interest rates will be at the end of the year or sometime in 2019.
The hawks on the ECB are pushing for tighter monetary policy, but they are coming up against ECB President Mario Draghi, who is one of the most influential central bankers of the past couple of decades. He’s managed very effectively to tie the hands of the ECB through forward guidance and it will take a lot of effort to override. As I see it, Draghi is working hard to keep monetary policy as loose as possible for as long as possible in order to minimize downside risks to the economic recovery. That will be the big question this year. Can he keep the ECB on course when there are more and more hawks trying to push him away from this stance? Given Draghi’s outsized influence, I expect rates to rise only gradually in 2018.
Q. Where is the euro headed versus the dollar?
A: I agree with my colleague, Jens Søndergaard (Capital Group’s currency analyst), that the euro is essentially trading at fair value, or roughly $1.20 to $1.24. At this time last year, the euro was significantly undervalued, but a subsequent rally against the dollar has changed that picture. In order for the euro to rise a lot more from here, we need to see higher European interest rates. Once the market starts pricing in higher rates, the euro could climb back to the levels we saw in 2014, or about $1.30 to $1.40.
Q. What are the implications for European equity markets?
A: Well, of course, we’ve already seen a strong rally in European equity markets. In 2017, the MSCI Europe Index rose more than 25% in dollar terms and about 13% in local currency terms. While it may be difficult to repeat those types of gains this year, I think European markets can continue to rise in this benign environment of strong economic growth and muted inflation.
Over the past 12 to 18 months, European equities reflected a more favorable economic environment, as well as diminishing political risks. That also boosted the currency, which was one of the key reasons for the outperformance of euro-zone stocks. Over the next 12 to 18 months, I think we could see European equity market gains that are driven more by the fundamentals, including higher earnings growth, without the reliance on further currency appreciation.
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