Greater budgetary rigour leads to weaker economic dynamic in Europe compared to the United States

While in the second quarter GDP accelerated in the United States due to the strength of domestic consumption, it slowed down slightly in the Eurozone. Europe’s weaker growth than that of the United States is primarily due to greater budgetary rigour.

In the second quarter, US GDP increased at an annual rate of 2.8%. Economic activity was chiefly sustained by the strength of domestic consumption, which benefited from the December 2017 tax reform, and by an increase in public spending. In the eurozone, GDP growth slowed slightly in the second quarter, coming in at an annual rate of 2.1%. “Europe’s weaker growth than that of the United States is primarily due to greater budgetary rigour.

The outlook for equity markets in the short term depends on how the trade war between the United States and China pans out
Equity markets advanced in July. Over the month, the S&P 500 in the United States (in USD), the Stoxx 600 in Europe (in EUR), the Topix in Japan (in JPY) and the MSCI Emerging Markets (in USD) gained respectively. “Equities benefited from the publication of good quarterly company earnings and the appeasement in the trade war between Europe and the United States, after US President Donald Trump had indicated he would not impose new tariffs on the import of European cars to the United States”, says the Luxembourgish economist. “The outlook for equity markets in the short term largely depends on how the trade war between the United States and China pans out, given the threat of tariffs on 200 billion dollars’ worth of Chinese imports.”

Monetary policy remains unchanged in Europe and in the US
As expected, the US Federal Reserve left the Federal Funds rate unchanged at its 31 July – 1 August meeting. In its press release, it described the pace of economic growth as “strong” (compared to “solid” previously), suggesting an interest rate hike at its next meeting at the end of September. In Europe, the ECB also left its monetary policy unchanged. As previously announced, it will reduce its net asset purchases from 30 billion euros at present to 15 billion euros from October and end its quantitative easing programme by end of the year.

Government bonds continue to be an unattractive asset class
Bond market yields firmed up slightly in July. Given the appeasement in the trade war between Europe and the United States following the visit of European Commission President Jean-Claude Juncker to US President Donald Trump, investors have shown little enthusiasm for government bonds. With such low yields on offer, government bonds continue to be an unattractive asset class. Their main interest for investors is as a safe haven in times of crisis.

Guy Wagner, chief investment officer at BLI – Banque de Luxembourg Investments

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