Has a declining oil price saved the Eurozone?
After a year of tentative recovery in 2014, the latest EY Eurozone forecast expects growth in the Eurozone to accelerate in 2015 With GDP growth increasing from 0.9% in 2014 to 1.5% this year and then to 1.8% in 2016. The movement in oil prices since the previous EY forecast in December 2014 has undoubtedly had a major impact and is likely to boost real household income by 1.5%, enabling consumer spending growth to accelerate from 0.9% in 2014 to 1.6%. A very healthy rate when set against recent experience.
…to an extent, but policy is also playing a role…
The ECB’s recent announcement of substantial sovereign bond purchases is expected to prevent a deflationary spiral and underpin medium-term inflation expectations at 2%. The impact of QE is already been seen in the falling value of the Euro which will boost exports. But experience in the USA suggest the impact of QE will go beyond the exchange rate and is likely to impact asset prices positively and keep interest rates lower than would otherwise be the case.
…even in unexpected areas.
Stronger domestic and external demand, plus improving access to finance, should underpin business confidence and spur faster capital spending. Alongside a tentative recovery in housing markets and stabilizing public investment. Rising growth and lower borrowing costs will have a positive impact on public finances in next few years. But with public debt above 90% of GDP in eight countries (and 96% for the Eurozone overall), room for fiscal easing is limited. Nevertheless the period of emergency austerity is over, and EY expect government spending to contribute modestly to growth.
However there are still risks to the outlook…
Threats to stability remain – principally from the prospect of difficult negotiations over Greece’s situation. But at least these discussions are taking place in an improving macroeconomic and financial environment in much of the rest of the Eurozone. The conflict in Ukraine will also continue to pose a risk to confidence but, with much lower global energy prices, one of the key transmission mechanisms of a spiralling conflict to the Eurozone looks to be less potent.
…and longer-term challenges.
The EY forecast sees growth slowing to 1.6% between 2017 to 2019 as the boost from lower oil prices and QE tapers off and productivity limits the pace of future growth. The improvement expected over the next two years provides policy-makers with some breathing space but reform is still required. Policy-makers in the Eurozone now have an opportunity to push ahead in more favourable circumstances. With an improvement in growth some of the pain of restructuring may be eased: it is vital they seize the moment.
Now is the time for business to re-assess their position in the Eurozone
Business has adopted a cautious approach to the Eurozone in recent years, shoring up operations and limiting investment. We can see this clearly by comparing capital investment and M&A values and volumes between the USA and the Eurozone. Over the last few years and especially since 2012, the rate of activity by US companies has been significantly higher than their Eurozone peers. More capital has been invested in the USA and more deals have been done and the gap has widened.
This is not an unexpected observation as economic growth has been stronger in the USA and corporate profitability has been higher. Valuations and earnings multiples are now significantly higher in the USA but with growth returning, a weaker Euro and QE likely to impact European valuations in a positive fashion: the relative attractiveness of investing in the Eurozone is increasing. Moreover, QE and the work of the ECB to rebuild trust in the banking sector mean that there is likely to be more finance available and at competitive rates. We are already seeing US companies look to raise finance in Europe, taking advantage of the favourable combination of lower interest rates and a weaker Euro.
Our experience suggests M&A activity and capital investment tend to increase when growth is good, valuations are increasing and profits are improving. The Eurozone could well move positively in all of these areas in the coming months, especially for investors that benefit from a weaker Euro. the early signs are promising, the first two months of 2015 have seen the highest non-European M&A values since records began, with 40% coming from companies based in the USA.
The Eurozone is in play. Companies that want to buy for growth or to consolidate their positions are likely to see more opportunities emerging, while potential sellers should start preparing their assets now. Financing will increasingly be available to support capital investment and early movers could establish a first-mover advantage given the low levels of modern capacity added in recent years.
The longer-term remains challenging and a careful analysis of potential returns is still required. But now is the time to re-visit the strategy for the Eurozone and set out a long-term vision and short-term plan. As emphasised many times in the recent past, this should reflect the differences by geography, sector and segment very clearly.