That inflation has been unwelcome to businesses and households, but it has at least allowed the cash level of GDP to keep growing. That, in turn, has made the job of taming the public finances easier than in the European periphery.
This may sound heretical, but it’s a matter of simple arithmetic. Since the deficit and debt are measured as a share of nominal GDP, anything that boosts the denominator (cash GDP) will make it easier to shrink the numerator (debt or borrowing).
It goes without saying that it would be better to have a strong economic recovery to push up the level of nominal GDP in these economies. But if that’s not on offer in an environment of structural reform and subdued regional demand, it’s all the more important to have at least a modicum of inflation to keep the cash value of the economy going up.
Investors are right to be encouraged by signs of growth in the eurozone, and the widespread belief that the periphery economies are past the worst. But the current very low level of inflation in the crisis economies could make it harder for them to achieve a self-sustaining recovery in the coming year.
The key takeaway is that one should be wary of European investment strategies that assume an early and rapid resumption of earnings growth in the troubled economies, on the back of strong macroeconomic recoveries.
The other broad investment conclusion is that for the eurozone, the turn in the interest rate cycle could be even further away than previously thought.
Chances are the eurozone will avoid deflation in 2014. But even the possibility that large parts of southern Europe could see falling prices next year ought to make policymakers very worried indeed.
Stephanie Flanders is chief market strategist for the UK and Europe at JP Morgan Asset Management
THE BULLS
Dean Tenerelli, European equities portfolio manager, T Rowe Price
“European equities are undervalued and the economies are recovering. Luxury-goods companies, banks in consolidated markets, broadcasters, and Spanish utilities are a few examples of where we see opportunity.
“The macroeconomic environment has transformed from an end-of-the-world scenario and fears of a eurozone break-up, to a story of improving confidence, modest recovery and improving company fundamentals.”
Asoka Wöhrmann, co-chief investment officer, Deutsche Asset & Wealth Management
“The ECB will play a crucial role this coming year. In 2014 we will not see restrictive monetary policy, but rather consolidation in the banking sector, something that is already concluded in the USA with more than 450 financial institutions being wound up.
