Friday, 16 November 2012

Week in review: Europe’s (re)Balancing Act


As the UK emerges from recession, Europe officially descends back into it. The reality, of course, is that this is just a statistical event; growth in the eurozone has been virtually non-existent for quite some time and the underlying trend for the region is one of stagnation, not collapse. So the recession may not be as bad as it sounds but that won’t comfort the continent’s rioting masses. The silver lining is that Europe’s pain is symptomatic of a genuine rebalancing beneath the surface.
Source: Eurostat/Brewin Dolphin
Current accounts which show the flow of cash for trade and investment purposes between countries were symptomatic of the pre-crisis imbalances of the eurozone. Huge deficits (money outflows where countries are spending more than they earn) emerged in the uncompetitive peripheral European economies. We’ve discussed the French and German trade balances and the current account balances of eurozone countries before. Now, several thousand jobs later, the comfort comes in knowing that real progress is being made.

Current accounts when expressed as a percentage of GDP are shrinking. Given that countries are in recession, and therefore their GDP is shrinking, that means that imports must be shrinking even faster.
Source: OECD/Brewin Dolphin
Other advances have been made in terms of falling unit labour costs, which explains the decision of Ford and other like-minded countries to move production from ‘competitive’ countries like Belgium and the UK into ‘uncompetitive’ countries like Spain – a point we made with stacks of Ford Transit vans to illustrate relative labour market flexibility.

The story then is one of a long and painful rebalancing, but one which is making progress.

Notwithstanding this, the euro as a currency has been falling recently but bargain hunters propped it up this week. The risk premium may be back on the rise in the eurozone but the region as a whole runs a current account surplus – one of very few regions outside of the big oil exporters to do so. That creates natural demand for the currency which will increase as the recession intensifies. The euro was flat over the week. Sterling was also a touch weaker but the yen was the weakest currency falling more than 2% which, as we have pointed out before, elicits a strong response from the equity market. Japanese equities were one of very few markets to make gains this week, rising 3% as Prime Minister Noda dissolved parliament in anticipation of an election in December.

Easier monetary policy, is known to be favoured by opposition leader (and former prime minister) Shinzō Abe. Investors may cheer a more conciliatory economic programme but they are unlikely to welcome the more aggressive nationalist rhetoric which Abe will bring if he regains the premiership. Having publicly stated his regret at not visiting the Yasakuni Shrine, in which Japan’s war criminals are enshrined, during his last spell in top office he cannot be expected to be so diplomatic if he gets a second chance. Difficult Sino-Japanese relations, already inflamed by the dispute over the Senkaku (Diaoyu) islands, will likely therefore be a symptom of 2013.

Markets are approaching oversold territory and the underlying macroeconomic trend is positive. That should tempt investors in, even as uncertainty over the fiscal cliff looms.

Guy Foster
Head of Portfolio Strategy

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