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Brian Tora: German politics will determine the fate of the euro


The bucket and spade season is now in full swing, with trading volumes down and corporate news prompting wilder reactions in shares than otherwise might prove justified.

The one corner of the world that seems to have dropped out of investors’ sight is Europe, with little news expected ahead of the German general election, due next month. But events continue there, even as we continue to bask in warmer weather than we have experienced for some years.

Last week saw both employment figures and the inflation rate published for those countries within the single currency zone. Both were unchanged.

With the holiday season fully underway, jobless numbers were no doubt helped by seasonal hires, particularly in the embattled southern European nations. True, at a little over 12 per cent it remains high but at worst things appear stable and the situation might even demand a more positive interpretation.

Take inflation, for example. The headline rate was unchanged at 1.6 per cent, remarkable given higher food and energy costs, but core inflation was somewhat lower at 1.1 per cent. Strip out indirect tax rises and it falls to below 1 per cent.

What this tells us is that the European Central Bank has scope to maintain a low interest rate environment – undoubtedly welcome to those over-borrowed countries that desperately need a resumption of economic growth.

Then there is the credit cycle in Europe. Austerity and uncertainty have dampened the demand for credit, a sure indicator that economic prosperity is still a way off. 

But there are tentative signs that the cycle is turning. Expectations for both consumer and corporate credit demand are improving, admittedly in a patchy way across the eurozone, but this is a better picture than we have seen for some time.

The situation has been helped by a trend towards lower rates from the banks. While some balance sheet reinforcement remains a priority (Deutsche Bank has followed Barclays in deleveraging to meet the more stringent conditions imposed by regulators by announcing it will shrink its balance sheet), a renewed appetite for borrowing suggests growing confidence among both companies and consumers.

These may be small and inconclusive signs or they may be straws in the wind, signalling the start of the much-needed recovery in the fortunes of the countries of the single currency zone. 

Only time will tell but at least one piece of research that has crossed my desk in the past week has suggested that once markets resume a ‘risk-on’ mentality European shares could be among the principal beneficiaries.

Supporting this contention is the fact that share valuations are currently considered attractive. Dividend yields, for example, are above their 10-year average, while price earnings multiples reflect the fears that the outlook for European economies remains clouded. It is worth bearing in mind, though, that the outlook for corporates may not necessarily be the same as for nations.

So what could go wrong? The answer, of course, is plenty. Aside from the fact that an unexpected result in the German elections could throw the cat among the pigeons, none of the countries in the lifeboat manned by the ECB and the IMF are out of danger yet, while their populations are becoming increasingly tired of austerity.

It is estimated that 2 million Portuguese have emigrated to Brazil since these troubles began, mainly young and out of one of the smaller European populations. Greece has seen a similar exodus.

Having dinner with an eminent economist recently, she expressed surprise that the euro had held together this long and remained convinced it would fall apart. But like those doubters more than a decade ago when this great experiment was launched, she underestimates the political will. If the electorate allow it, Germany has the muscle to hold it all together. It could prove an interesting autumn.

Brian Tora is an associate with investment managers JM Finn & Co


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