Politics still weigh heavy on Europe’s economy, says Ashburton’s Tristan Hanson

Although sentiment indicators point to optimism, the pending Italian elections and political turbulence in Spain are reminders of the ongoing battle to drag Europe out of crisis, says Tristan Hanson, head of Asset Allocation at Jersey-based Ashburton.

The ECB’s OMT (Outright Monetary Transactions) programme that was outlined in Q3 last year was a very significant policy shift and has brought calm to markets through its mere suggestion. However, a corruption scandal in Spain (denied by Prime Minister Rajoy and his party) and the improving prospects in the polls for Silvio Berlusconi and Beppe Grillo, ahead of the Italian general election next week, highlight the vulnerability of the current status quo.

Although the ECB’s firepower is substantial, the OMT is explicitly a conditional program – countries must accept the conditionality of an appropriate EFSF/ESM programme. Its implementation is therefore dependent on government leaders in stressed countries following through with policies acceptable to the EU and ECB. A centre-left coalition is seen as the most likely outcome in Italy but with the final polls suggesting a close race, a hung parliament result (or an unlikely right-wing victory) poses a material downside risk for markets.

While financial conditions have improved significantly since Draghi flagged the ECB’s policy shift last summer, any renewed sense of panic would occur against an economic backdrop that remains acutely weak. In spite of Germany’s recovery, the region’s largest economy, economic output for the euro-zone remains below 2007 levels.

Figure 1: Real GDP levels (December 2005=100)

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Source: Bloomberg, Eurostat, Ashburton calculations

Unemployment is also distressingly high in a number of countries. The consensus view among economists is that Europe will recover as the year goes on and enter a period of low but positive growth. With luck that will be the case, but as long as several countries in the region remain so depressed, the risk of growing social unrest and political uncertainty will inevitably loom.”

Figure 2: Unemployment Rates (%)

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Source: Bloomberg

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