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Monday 11 April 2011
Telegraph.co.uk Home News Sport Finance Comment Culture Travel Lifestyle Fashion Technology Jobs Dating Offers Companies Comment Personal Finance Economics Markets Your Business Olympics Business Fund Game Business Club Blogs Ambrose Evans-Pritchard Jeff Randall Damian Reece Jeremy Warner Richard Fletcher Kamal Ahmed Alistair Osborne James QuinnTom Stevenson
Eurozone's woes create opportunity for investors Three years ago, the European Central Bank (ECB) took fright at soaring commodity prices and raised interest rates by a quarter point in the face of an easing of monetary policy in the US and UK that had been running for nearly a year. With strong demand for its high-quality capital goods and premium brands in, for example, the auto sector, the German economy is Europe's biggest winner from the emerging market consumer boom. By Tom Stevenson 9:30PM BST 09 Apr 2011Comments
Within weeks, however, it had backtracked after the collapse of Lehman Brothers forced it to play catch-up in the worldwide race to monetary ground zero.
I think the ECB has got it wrong again and the market's expectation of another couple of increases in eurozone rates by the year-end will be misplaced. The profound flaw in the one-size-fits-all euro experiment means that interest rates cannot rise as fast as Jean-Claude Trichet, with one eye on the German dynamo at the heart of Europe, would like.
It is not hard to see why the ECB felt compelled to act. Germany, which accounts for nearly a third of the eurozone's entire economic output, is humming. After years as the "sick man of Europe", Germany scrapped collectively-bargained minimum wages, put a lid on labour costs and gave itself a huge competitive advantage compared with its profligate European neighbours.
With strong demand for its high-quality capital goods and premium brands in, for example, the auto sector, the German economy is Europe's biggest winner from the emerging market consumer boom. Companies like BMW cannot ship cars fast enough to China and the prospect of rising exports for years to come is feeding through to greater confidence at home. The domestic economy, too, is buzzing.
Around the edges, as Portugal demonstrated this week, it is a sorrier tale. With double digit unemployment in Greece, Ireland and Portugal (and a staggering 20pc in Spain) economic growth will be miserable if it rises above zero at all. The periphery is in a ghastly debt trap. It must make savage cuts to cure its deficits but this more or less guarantees that it won't generate the growth that would achieve the same end more quickly and more sustainably.
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26 Feb 2011It is hardly surprising that on one widely-used measure of the appropriateness of interest rates, – the Taylor rule, which says what the interest rate should be with reference to how far inflation is away from target and how far GDP from potential – peripheral Europe should have interest rates of minus 4.5pc while Germany should have a policy rate of plus 4.5pc. A quarter point here or there really makes no difference – the ECB rate is a dreadful compromise that works for none of the region's economies.
Another reason why European interest rates are not going to rise as fast as expected is the fact that, as in the US and the UK, underlying inflation is not as high as the hawks would have us believe. Weak income growth and still high spare capacity mean the core inflation rate is around 1pc, around half the ECB's target. With peripheral eurozone countries facing massive hurdles to regain a semblance of competitiveness, wages will remain under pressure for years.
Two other reasons point to the rate rise being premature. First, the strength of the euro is itself a kind of monetary tightening, reducing GDP as surely as interest rate rises can. Second, the preponderance of floating rate mortgages in the periphery means that higher rates will be felt disproportionately in the countries where the property market is already on its knees. Germany and France, where the cooling is required most, are, like the US, insulated from higher mortgage rates by the popularity of fixed rate deals.
Last week's rate hike has a number of implications for investors. The general point is that the beginning of a tightening cycle is rarely good for equity markets, especially if it coincides with a persistently high oil price and, in the case of Europe, the most sluggish earnings recovery in the developed world. But interest rate rises are not always bad for markets, especially starting from such a low level.
The more interesting question is what might happen if I am right and the periphery's struggles mean that rates stay lower for longer than has been priced into markets today. In that case, policy may remain too loose for Germany for an extended period and the comparative advantage of the core will get progressively bigger. The failure of the one-size-fits-all monetary policy may be a headache for Europe's central bank but for investors it creates plenty of opportunities to take advantage of the widening growth differentials between the core and the periphery.
tomrstevenson@fil.com
Tom Stevenson is an investment director at Fidelity International. The views expressed are his own. www.twitter.com/tomstevenson63
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