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When ‘bad’ is ‘good’

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Joel Copp-Barton, European Equities Product Director at Invesco Perpetual, shares his views on Europe’s recovery…

Recent Purchasing Managers Index data is questioning the speed at which Europe can recover. The uncertainty caused by Italy failing to elect a government and the impact on short term confidence from the prolonged Cyprus bailout process undoubtedly weighed on these surveys in February and March. The flash estimate for April was the first overall reading which didn’t disappoint expectations for a couple of months, though it still stayed below the key 50 level, at which point economic growth tends to re-emerge.

The make-up of the April number was also intriguing: Germany fell short, France – a recent laggard – was less bad than expectations. One read of this would be negative – even Germany isn’t immune – but actually as we explain below this may, perversely, end up being no bad thing.

It is also worth pointing out an over reliance on shorter term activity measures can obscure some of the medium/long term indicators. Eurozone M1 Money supply for example is growing strongly, which historically has been consistent with a pickup in economic growth at some stage in the future.

Against this backdrop it would be naïve to expect the ECB to sit on its hands. A cut in interest rates was a much discussed topic at the last ECB meeting on 4 April 2013 following disappointing activity data in February and March. The final decision was to leave rates unchanged at that stage, leaving the impression that a continuation of this weakness could result in future action. Since then European and global economic activity has been disappointing. Softer data even out of Germany will, if anything, increase the chances of a cut in interest rates and potentially further/other action. We note that economists are now starting to forecast some reduction in European interest rates.

Under Mario Draghi, the ECB has proven itself to be more adept in helping address some of the challenges facing Europe. The proposed OMT facility is such an example. Hence, to assume the ECB does not implement other measures is probably unfair in our view. Such an example is those Small and Medium Enterprises (SMEs) struggling to get financing in some of the peripheral countries. Mindful of its mandate and the various parties involved, the ECB still appears to have some options open to it. These possible options range from some form of guarantees to SMEs to specific Asset Backed Securities and loosening of collateral requirements. As highlighted by Mario Draghi’s now infamous speech “to do whatever it takes”, betting against the ECB can be a dangerous game.

By the way… European markets reacted by rising with the DJ Euro Stoxx 50 Index rising 3.07% on the day!

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