19 to 25 June: Body Swap

In 2015 and early 2016, the UK was a bright spot for developed world growth. Meanwhile, much of Europe (led by France and Italy) languished in a post-crisis quagmire, hampered by indecision and bureaucracy. This year, the dynamics appear to have reversed.

In the UK, Theresa May’s decision to call a snap general election backfired spectacularly. After a limited and inconsistent campaign, the Conservatives lost their small majority in parliament. In the aftermath, the Prime Minister has not done much better; an agreement with the DUP in Northern Ireland is still outstanding and there is a sense of an overall lack of leadership. Similarly, there is discord at the Bank of England – with a division between the dovish Governor, focused on the weak growth picture, and a more hawkish minority (including the Chief Economist), concerned about recent inflation and low levels of unemployment. After a period “defying gravity”, with resilient consumer spending and exports benefitting from better global growth and a weaker GBP, the UK economy is weakening. On current evidence, we worry about the ability of government to manage Brexit negotiations and think policy uncertainty will create a further drag.

Meanwhile, Europe is enjoying its day in the sun. In France, socialist Francois Hollande (whose politics led to the nickname “Flanby”, a jelly-like caramel custard) was decisively beaten by Emmanuel Macron in the Presidential election, with the latter’s centrist “En Marche” party (formed only 14 months ago) capturing a convincing majority in parliamentary voting. This has resulted in a surge in business sentiment (May composite PMI and INSEE Business climate indicator both at 6-year highs). In addition, the Italian banking system is finally addressing the insolvency and undercapitalisation of many of its participants. Earlier this year Unicredit raised EUR 13bn in capital, this week 2 mid-sized banks from the Veneto region were put into wind down and shortly (there is some doubt about the feasibility of the announced plan) the world’s oldest bank, Monte Paschi, should receive state aid to address its monster book of non-performing loans. Last, the usually dysfunctional ECB mostly appear to be sticking to a single script, keeping policy easy based on low inflation.

Over the longer term, we’re not convinced this “body swap” will continue. In our opinion, the European resurgence is more a case of “every dog has its day”; as Greece has demonstrated, the Euro fundamentally doesn’t work and whilst Italy may enjoy improved confidence in the near-term, underlying growth potential is weak and its fiscal position is far from being addressed.

In commodity markets, oil prices entered a bear market (a decline of over 20%). WTI prices have no fallen over 25% YTD from their high on the 1st January at USD 58.30 and dipped below USD 43 for the first time in 18 months.

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