23 Aug 2018
Global macro review: the paradox of Europe
As the United States continues on its growth trajectory, policymakers and investors alike are looking to ascertain whether Europe and the UK can narrow the growth gap as we approach the last quarter of 2018.
Eurozone soft patch
Recent Eurozone data has disappointed, causing some reduction in investor confidence. The purchasing managers’ index (PMI) slipped, as did the Economic Sentiment Indicator (ESI), retail sales and manufacturing growth across the Eurozone. These indicators are still high enough to signal robust activity even if their acceleration slowed recently.
The European Central Bank forecasts Eurozone growth at 2.4% in 2018 and 1.9% in 2019, supported by favourable financial conditions, expanding business investment and sustained export strength. Headline inflation is expected to rise to 1.8% by 2020.
Geopolitical risks within the Eurozone have decreased, and the Eurobarometer shows rising confidence in Europe’s prospects and rising public trust in the EU standing, which is now at 42%, the highest since 2010.
There is a material exposure for South African investors to the real estate sector where conditions appear favourable due to strong rental fundamentals and lower capitalisation rates.
In late April, the pound reacted negatively to the sharp slowdown to 0.1% quarter-on-quarter in the first
estimate of real GDP growth for the UK, driven by a sharp fall in construction output and a sluggish manufacturing sector. Year-on-year growth in UK real GDP was 1.2%, and although UK growth was better than expected in 2017, it was substantially below the 2.5% in the US and 2.7% in the Eurozone in late 2017.
The latest economic indicators suggest some moderation in the pace of growth since the start of the year. This was probably because of the unusual strength of indicators in late 2017, which were consistent with GDP growing at an annual rate of around 3.5% to 4%, an unsustainably high level.
Understanding the broader macro risks
The Eurozone economy is out of phase with the US and lagging it by an estimated three years. That said, the current state of the Eurozone economy bodes well for European equities and real estate companies. Loose financial conditions, easier lending conditions, strengthening demand and low stable ECB policy rates continue to push European capitalisation rates down, for all the right reasons.
Brexit uncertainty continues to affect fixed investment growth, and the industrial production growth decreased by 0.1% quarter-on-quarter to February 2018 due to a sharp drop in mining, as a result of the shutdown of the Forties oil pipeline in December 2017, and refinery shutdowns in January and February 2018.
A two-year transition period for Brexit was never going to be enough time to negotiate a comprehensive Brexit deal, especially if negotiations had to be finalised by Autumn 2018, to allow time for the deal to be approved by the respective parliaments. The transition period has been extended to the end of 2020, which ends the UK’s obligations to the EU but does not finalise trade or the customs union. Rather than reducing the anxiety that business has over Brexit in the short term, this just extends it.