Fiscal easing: could the Eurozone surprise to the upside in 2019?

In this month’s video, Investment Specialist, Kirsty Clark looks at the prospects for the euro area in 2019 as the region embarks on its most accommodative fiscal policy of the last decade.

 

Equity markets continued to trend higher in April, supported by economic data surprises and a slowdown in the rate of downgrades to corporate earnings estimates. Over the month, developed markets outperformed their emerging market counterparts.

At a regional level, Eurozone equities led the gains after delivering stronger-than-expected economic growth, while a pick-up in net exports in the first quarter helped to lift Italy out of recession.

US equities also performed well. The S&P500 index logged another record high, despite the US Fed maintaining its dovish stance.

UK stocks managed to stay in positive territory as concerns around Brexit eased. During the month, small and mid-cap stocks outperformed their large cap peers. Japanese equities were the regional laggards, but the TOPIX finished up as the Heisei era drew to a close.

Elsewhere, improved sentiment prompted a sell-off in 10-year German bunds and US treasuries. Gold also gave back some of last month’s gains. In contrast, Brent crude continued its upward climb in April. It briefly rose above US$75 a barrel before retreating in the final week of the month.

In currency markets, the US dollar strengthened against the euro, but weakened against sterling and the Japanese yen.

From a sector point of view, cyclicals outperformed defensives in April. Tech stocks continued to benefit from progress in the US-China trade talks, while financials bounced back following a solid first-quarter earnings season. Healthcare and utilities were the laggards over the month.

Prospects for growth in the euro area have, once again, been in focus this year. Encouragingly, Eurozone GDP growth accelerated in the first quarter of 2019 after a sharp slowdown in the second half of last year. The economy was supported by domestic demand; however, external factors such as trade disputes and ongoing Brexit uncertainties continued to weigh on growth in the region.

With talk of a sustained recovery still some way off and, amid the rising anti-austerity rhetoric, there have been renewed calls, including from governing bodies such as the IMF, for coordinated fiscal easing across the euro area to stimulate economic growth…and, authorities have been listening.

In 2019, the region looks set to embark on its most accommodative fiscal policy of the last decade.

While sovereign debt remains higher than it was at pre-crisis levels, the debt burden has come down in recent years – partly due to the lower interest rate environment.

In aggregate, debt in the euro area is on a downward trend, which should allow for for greater fiscal stimulus without jeopardising debt sustainability.

The fiscal stimulus efforts are being led by Germany, France and Italy in particular.

Despite Germany’s ‘black zero’ policy of maintaining a balanced fiscal budget, the country has the most scope to undertake fiscal easing, and is expected to provide the greatest stimulus. In addition to measures already agreed by the ruling coalition, the government is embarking on higher social spending and further tax cuts in 2019.

In France, President Macron has also announced a raft of tax cuts and pension reforms, combined with measures designed to increase purchasing power.

In Italy, ‘universal income’ is the main pillar of the coalition’s fiscal policy in 2019. After a lengthy stand-off with European officials in Brussels, the populist leaders eventually reached a compromise on their public spending initiatives.

Planned public investment is highest in Portugal, where the country’s economic turnaround has led to faster growth than the Eurozone average over the past two years.

Overall, expansionary fiscal policy should support business and consumer confidence in the euro area. Tax cuts should also boost domestic demand, while accelerating wage growth continues to support consumers’ purchasing power.

The combined fiscal stimulus measures should boost Eurozone GDP growth in 2019 and also provide a tailwind into 2020.

At the same time, we expect a progressive moderation in the external factors that have been dragging on the economy, offering a further tailwind for growth.

The Eurozone continues to face cyclical and structural challenges, and sentiment towards the region is likely to remain fragile in the run up to European elections, and with a change at the helm of the ECB as Mario Draghi’s tenure draws to an end.

Uncertainty around these events could bring further bouts of market volatility as we move through the year. Still, given the current weak sentiment towards the region, a low bar has been set for positive surprises.

Although it may be premature to suggest that Europe is ‘turning the page’ on austerity, this renewed round of fiscal stimulus should, at the very least, stave off concerns of an imminent recession and provide a respite from the austerity drive of the recent past.

The measures, combined with continued loose monetary policy, a healthy labour market and a resilient corporate backdrop, may yet see the Eurozone bring some welcome surprises in the months ahead.


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