Eurozone politics have entered a period of calm after sparking market turbulence with a series of high-risk events since mid-2016. Long-term challenges including slow growth, integration of immigrants and decreased competitiveness remain. Yet we see a steadier political environment supporting sustained, above-trend economic growth and some reform, and helping make the case for investing in the region’s equities.
Europeans are feeling more confident about the future. Popular support for the euro single currency has risen to the highest since 2004, as the blue line in the chart indicates. Our BlackRock GPS (green line) shows consensus forecasts for economic growth in Germany, France, Italy and Spain—the four largest eurozone economies—are near their 2015 peak.
Anti-Europe threat fades
The potential for extremist politics to become mainstream has faded in recent months, we believe, and prospects for reforms look brighter than they have in years. In Italy, the likelihood of an anti-euro government has dwindled, as no major party is pushing to exit the eurozone. In France, President Emmanuel Macron is expected to implement his largely pro-growth agenda with the help of a solid majority in parliament. His labor market reforms are off to a good start, with a batch of reforms expected to be enacted shortly without major protests. Angela Merkel was widely expected to win a fourth term as German Chancellor on Sunday. The key unknown is whether her coalition partner will be the pro-European Social Democrats (SPD) or the pro-business Free Democratic Party (FDP), which has a more reluctant stance on European integration. Overall, there is a pro-reform wind blowing in Brussels and key European capitals.
The risks? Economic growth dampens the urgency to reform, and differing views on which reforms are needed are too large to overcome. Italian elections in the spring are likely to cause political and financial turbulence along the way, and eventually produce a hung parliament. We see this limiting the scope for the reforms and fiscal adjustment that Italy needs to keep its large debt sustainable.
Bottom line: A largely benign European political backdrop looks to be setting the stage for a favorable investment environment in the near term. This adds to sustained above-trend growth and ongoing monetary accommodation. A much stronger euro is another risk. This would be a threat to corporate earnings and export growth, and could complicate the European Central Bank’s efforts to reach its inflation target. We prefer European equities to credit in this environment.
Read more market insights in my Weekly Commentary.