Jonathan Marriott – Chief Investment Officer, LGT Vestra
Following the election of Macron, is it time to increase exposure to Europe? Or are there still long-term structural problems in the region?
At the start of this year political risks seemed to be high. The vote for Brexit, the vote for Trump and the rise of non-mainstream so-called ‘populist parties’ in Europe raised concerns of radical political changes. Elections in Holland, France, Germany and possibly Italy in 2017 gave the chance for more upsets. The Dutch election passed off quietly and, while he is not from a mainstream party, Macron’s politics are centrist. In the end, the feared rise of Le Pen and the Front National faded. In Germany, Merkel’s popularity appears to be recovering and the right-wing Alternative für Deutschland (AfD) is unlikely to be a threat in the election later this year. Italy may still have an election this year but this is unlikely to be before September when a large number of MPs have done four and half years service and qualify for a lifetime pension. Here, the problem is the anti-EU and anti-establishment Five Star Movement, which could end up with a significant presence in parliament. To conclude, political risk has abated but has not entirely gone away.
Economic data in Europe has begun to improve from a low base. Purchasing managers’ index (“PMI”) data across Europe has been moving higher and unemployment, whilst still high, has started to fall in many countries. Macron with his pro-reform agenda may help move this along if he can get sufficient support in parliament after the upcoming parliamentary election. In terms of valuation, European equity markets still look cheaper than many other regions of the world despite having outperformed this year, already rising more than the UK, US and Japan. When our equity analysts look for attractive equities in the region, they still struggle to find a great deal of companies with the desired growth profiles.
Overall, the picture for European equities remains more positive than before the elections but some issues remain.
This month the Bank of England’s Monetary Policy Committee voted 7-1 to keep rates on hold. When should we expect them to raise rates?
Inflation, as measured by the consumer price index (“CPI”), is currently at 2.3% which is above the Bank of England (“BoE”) target of 2% and is expected to rise further in the coming months. They blame the rise in inflation largely on the move in sterling since the Brexit vote last year. The Monetary Policy Committee (“MPC”) has the flexibility to override the inflation target should it have an adverse effect on the economy as a whole. They commented that “attempting to offset fully the effect of weaker sterling on inflation would be achievable only at the cost of higher unemployment and in all likelihood even weaker growth”.
Their central economic forecasts are built around the UK getting a trade agreement and a smooth transition for Brexit. When questioned about this in the press conference, the Governor was diplomatic in saying this was the aim of both the UK government and EU officials and therefore it had to be their central view. He declined to speculate on the possibility of a less favourable scenario. In the quarterly report they stick to this line but still allow for a wide range of outcomes in the fan charts showing possible growth and inflation in the next three years.
We have been expecting the inflation rate to rise this year and it has exceeded the previous BoE expectations. The BoE expectation is for inflation to moderate in 2018 but to remain above target for the next three years; this is partly due to low unemployment, declining net immigration and as a result higher wages. As we get further into the forecast period we are more likely to see the impact of the Brexit negotiations which make predictions less reliable.
The BoE commented that they expected that rates could rise faster than the market priced in. However, this is subject to progress on Brexit and we do not see them being in a position to raise rates this year.
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