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Euro vision

The exceptional measures taken to stimulate world economic activity and boost business and consumer confidence following September 11 are beginning to have the desired effect.

Not only are there increasingly clear signs that the downward momentum in global growth has faded, but there is also growing evidence of improvement. Within the pan-European region, the UK stands out as the economy that has been most resilient in the face of an adverse economic background worldwide, largely due to the strength of consumer demand.

But robust consumer spending has also helped the French economy. Spurred by low borrowing costs, French consumer spending has risen for five consecutive months, raising hopes that its economy will avoid the recession that threatens Germany.

Economic growth on the Continent is likely to remain relatively subdued, but we foresee an improvement over the year – partly in response to a general upturn in the world economy. In addition, it is feasible that the European Central Bank will ease policy slightly, given the positive outlook for inflation.

Last year&#39s cautious approach to lowering interest rates was largely due to the fact that inflation was well above the bank&#39s 2 per cent target but this constraint will not be relevant if inflation falls to 1 per cent as we anticipate.

Further downward pressure on inflation will come from the oil price, which appears set to remain low. With inflation under control in Europe, we believe the likelihood of rates being raised once a recovery becomes more evident is comparatively slim.

The situation in the UK is somewhat different. Although economic growth is expected to be well below trend in the first part of the year, we believe it will remain clearly positive and will return to a level above trend later in 2002.

This alone could lead the Bank of England to raise interest rates to counter potential inflationary pressures. However, the fact that the bank&#39s monetary policy committee has always made it clear that the main motivation for last year&#39s rate reductions was the deteriorating global background and its potential impact on the UK lends additional weight to the prospect of higher rates.

Against this background of improving economic growth, we believe pan-European equity markets are poised to deliver positive, albeit modest, returns this year. The autumn rally that followed September 11 reflected investors&#39 willingness to look through the prevailing bad news to the pros-pect of recovery. That rally has come to an end and markets now await proof that their expectations will be met.

Proof in the shape of encouraging economic releases and better than expected corporate results is undoubtedly emerging, albeit sporadically. In the UK, unemployment remains low, wages growth is firm, house prices are still on the way up, and consumer confidence is buoyant.

On the Continent, both industrial and consumer confidence appear to be rising and there is evidence to suggest that the German economy,one of those most badly affected by the global slowdown, may have bottomed out. Against this, however, unemployment in both Germany and France has continued to rise.

On the corporate front, there has been positive news from various quarters. In the telecoms industry, Nokia achieved better fourth-quarter results than had been anticipated and also increased its forecast for sales of mobile phone handsets in 2002 from 380 million to between 420 million and 440 million.

This follows a tough year for the industry, when many of the company&#39s competitors were forced to cut prices drastically to make sales. Similarly, BMW, the German luxury car maker, saw fourth-quarter sales rise substantially over the previous quarter on strong demand for its 3-series and the new Mini.

At the moment, these positive releases are relatively isolated and there is undoubtedly more poor news to come, particularly from those companies less likely to benefit from a cyclical recovery. As a result, the high level of sector volatility that has been a feature for some time now is likely to persist.

This in itself can create excellent stock-specific investment opportunities but we are also confident that the underlying trend in pan-European equity markets will be upwards, as positive news comes to outweigh negative.

Various other factors will also contribute to a more rewarding year for European equities. The implementation of tax and pension reform in Germany through which the public will be encouraged to make greater personal financial provision for the future is likely to provide support for the region&#39s equity markets.

Last month&#39s successful introduction of the hard euro currency should also have a positive impact. The euro was already the second most tra- ded currency by volume on international money markets, ahead of both the yen and sterling. With the advent of the hard euro, retailers in countries outside the eurozone have indicated their willingness to accept it. There have been calls within Denmark for the country to hold another referendum on whether to join the currency. Even in the UK, recent surveys show the currency&#39s popularity is rising.

Over the longer term, we expect the euro to act as a catalyst for consolidation and restructuring throughout the eurozone as the single market reaches its full potential – a prospect that we believe augurs well for corporate earnings and hence for the region&#39s equities&#39 long-term performance.

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