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The ECB has increased its key deposit rate – or how much interest it pays on deposits - to 0.75% from 0% and lifted its key refinancing rate – or how much banks have to pay when they borrow from the ECB - to 1.25% from 0.5%.

"Price pressures have continued to strengthen and broaden across the economy," said the ECB.

"I cannot reduce the price of energy," said the president of ECB Christine Lagarde.

"I cannot convince the big players of this world to reduce gas prices. I cannot reform the electricity market. And I am very pleased to see that the European Commission is considering steps to that effect because monetary policy is not going to reduce the price of energy," she continued.

Lagarde added that if gas prices continue to "skyrocket", a recession would be on the horizon. If Russia were to fully cut gas supplies to the European Union and it becomes impossible to secure alternative gas supplies from the US, Asia or Norway, the ECB expects gas rationing across the Euro area and a recession in 2023.

Energy prices, which were up 26% compared to a year earlier, remain the key driver behind the jump. However, increases for food, services, and imported goods were also notably above the EBC’s overall 2% inflation target. 

As the economy began to recover from the initial shock of the pandemic last year, price growth took off, catching the ECB off guard. 

Supply-chain bottlenecks reducing the availability of consumer products also added to the upward pressure. Meanwhile, after lockdowns forced them to save up disposable incomes for several months, many households are now spending widely on everything from restaurant meals to new vehicles. 

Many of these inflation drivers are temporary, meaning price pressures will likely ease off gradually. The ECB predicts inflation will return to below 2% by the end of this year. However, this is a prediction questioned by a number of policymakers who believe above-target inflation readings could persist into 2023. 

Despite the uncertainty, the need to find secure and stable income is still a priority for investors and Europe’s real estate industry does offer substantial potential to achieve this in 2020, even as it moves through the ongoing late cycle. Investors are certainly seeing potential in the logistics sector, for example, which has been expanding for some years now, thanks to increasing urbanisation and the continuing growth of e-commerce driving the need for the provision of first-rate distribution centres.

The offices sector is also growing as central business districts are developed in several major cities across Europe while it is no surprise that German cities are regarded as investment hotspots by global investors, who value the safety afforded by scale, liquidity and growing markets. The same applies to Lisbon because of its attractive development and investment opportunities. Additionally, increased investment flows are expected to come from Asia, and especially Japan.

But with the wider economy slowing, the reality is that although global investors remain positive about real estate, there are familiar concerns surrounding the scarcity of attractive assets. Indeed, most markets are certainly quieter at present than this time last year. Although European real estate remains highly liquid overall, expectations are lower regarding the availability of equity and debt as the industry navigates the late-cycle.

Global investment opportunities and changing attitudes

At present, investors are faced with the challenge of how to effectively deploy capital and keep a sustainable cash-flow because of the increasing demand, and therefore prices, of European core real estate assets, which are perceived as safer in the current environment. Several investors are also adopting a build-to-core strategy as an alternative approach to generate income, while alternative real estate assets and residential properties are also being considered as additional investment options. This demonstrates an industry that is slowly challenging traditional investment norms and looking at real estate more broadly while acknowledging possible risks.

Asset owners will need to adapt their assets or convert them to meet changing demands.

Downturn is likely to be relatively gentle

Although the end of the investment cycle does appear to be approaching, the slowdown is likely to be a gentle one. It is unlikely to be as severe as the one seen in 2008, which was caused by a rare, seismic event. And when the next downturn does occur, markets are likely to make a quick recovery.

Investors are sharpening and improving their investment strategies to prepare for the stuttering growth and end-of-cycle risks, though. They are diversifying the economic drivers to which their portfolio is exposed. For example, investors are now considering investing in the alternatives and residential assets as mentioned above. Investors may also decide to invest in multiple sectors rather than one. This does not mean that their views of the real estate sector have changed; they are simply taking precautions by acknowledging that now is not the time to make huge investments.

The fact that the Eurozone is currently regarded as a safer investment destination by global investors still holds true with some chronic challenges. Pricing and scarcity of attractive assets are still the major challenges for investors. This is only exacerbated by the economic uncertainty and geopolitical events in some European markets, and the ongoing decline in consumer confidence.

Technological trends in the sector

Apart from the end-of-cycle warning signs and the decline in consumer confidence, another factor that investors need to consider is technology, which is driving change across all industrial sectors, not just real estate. Mobile technology has major implications for the retail sector, while the concept of driverless cars has raised the prospect that parking structures may well be converted to office or retail spaces in the future. People’s attitudes on how they occupy space continue to change: the advent of the co-working and co-living concepts are having a dramatic impact on the real estate industry. According to a report by PwC, the shared office space market is now going through a revolution, with co-working offices on the rise and likely to account for 30% of corporate office portfolios by 2030.

The Eurozone’s performance in real estate over the last year has been weaker compared to two years ago because of a decline in yields.

Challenges and opportunities ahead

For many asset managers, rapid technological changes are threatening to make some assets obsolete. Asset owners will need to adapt their assets or convert them to meet changing demands. This is more apparent in the retail sector as the number of physical stores continues to decline. To remain competitive, real estate owners will need to become operational businesses and develop new skills. They will also need to be able to understand and meet different consumer needs and expectations.

Virtual data rooms offer key benefits to the real estate sector

But one technological development that offers major benefits for the real estate sector is the use of virtual data rooms (VDRs). It enables investors to take full advantage of market opportunities by enabling them to respond quickly. This is essential if they are to avoid the risk of missing out on a favourable sale. Just one missing document can sometimes block an entire deal, for example.

With Drooms’ VDRs, all incoming documents are indexed appropriately thanks to its ‘auto-allocation’ feature. Business processes such as mergers and acquisitions, commercial real estate sales and non-performing loans can be conducted securely, efficiently and transparently through Drooms TRANSACTION. Using this tool, authorised personnel can have controlled, online access to confidential data that are stored remotely. Additionally, our latest product Drooms PORTFOLIO facilitates intelligent and secure portfolio management of multiples assets throughout the hold phase, allocating bespoke data rooms to individual assets on a single platform. Its “transaction flag” functionality enables parties with admin rights to search and mark transaction-relevant documents for readiness.

VDRs also offer a solution to coping with the rise of ‘big data’, which represents one of the most significant challenges facing real estate market players. By tapping into big data, investors can enhance their decision-making across supply chains. But failure to do so, i.e. by not adopting the right technology, can lead to a severe loss in their competitiveness.

Yields are still attractive in Europe

The Eurozone’s performance in real estate over the last year has been weaker compared to two years ago because of a decline in yields. Nevertheless, global investors still see Europe as a haven for investment opportunities while expecting major disruption in Asia. The yields may have declined but they are still favourable versus the low-interest rates prevailing elsewhere and, despite the inevitable slowdown, there is still strong demand from investors for the right deals and investment strategies. Investors just need to remember that the right technology will be more indispensable than ever when the inevitable slowdown occurs.

 

Amidst the recent shock resignations of Brexit Secretary David Davis and Foreign Secretary Boris Johnson, investment uncertainty, slower economic growth and a weaker pound, the United Kingdom is on its way to a slow but steady Brexit, with negotiations about the future relations between the UK and the EU still taking place.

And whilst the full consequences of Britain’s vote to leave the EU are still not perceptible, Finance Monthly examines the effects of the vote on economic activity in the country thus far.

 

Do you remember the Leave campaign’s red bus with the promise of £350 million per week more for the NHS? Two years after the referendum that confirmed the UK’s decision to leave the European Union, the cost of Brexit to the UK economy is already £40bn and counting. Giving evidence to the Treasury Committee two months ago, the Governor of the Bank of England Mark Carney said the 2016 leave vote had already knocked 2% off the economy. This means that households are currently £900 worse off than they would have been if the UK decided to remain in the EU. Mr. Carney also added that the economy has underperformed Bank of England’s pre-referendum forecasts “and that the Leave vote, which prompted a record one-day fall in sterling, was the primary culprit”.

Moreover, recent analysis by the Centre for European Reform (CER) estimates that the UK economy is 2.1% smaller as a result of the Brexit decision. With a knock-on hit to the public finances of £23 billion per year, or £440 million per week, the UK has been losing nearly £100 million more, per week, than the £350 million that could have been ‘going to the NHS’.
Whether you’re pro or anti-Brexit, the facts speak for themselves – the UK’s economic growth is worsening. Even though it outperformed expectations after the referendum, the economy only grew by 0.1% in Q1, making the UK the slowest growing economy in the G7. According to the CER’s analysis, British economy was 2.1 % smaller in Q1 2018 than it would have been if the referendum had resulted in favour of Remain.

To illustrate the impact of Brexit, Chart 1 explores UK real growth, as opposed to that of the euro area between Q1 2011 and Q1 2018.

 

 

As Francesco Papadia of Bruegel, the European think tank that specialises in economics, notes, the EU has grown at a slower rate than the UK for most of the ‘European phase of the Great Recession’. However, since the beginning of 2017, only six months after the UK’s decision to leave the EU, the euro area began growing more than the UK.

Reflecting on the effect of Brexit for the rest of 2018, Sam Hill at RBC Capital Markets says that although real income growth should return, it is still expected to result in sub-par consumption growth. Headwinds to business investment could persist, whilst the offset from net trade remains underwhelming.”

 

All of these individual calculations and predictions are controversial, but producing estimates is a challenging task. However, what they show at this stage is that the Brexit vote has thus far left the country poorer and worse off, with the government’s negotiations with the EU threatening to make the situation even worse. Will Brexit look foolish in a decade’s time and is all of this a massive waste of time and money? Or is the price going to be worth it – will we see the ‘Brexit dream’ that campaigners and supporters believe in? Too many questions and not enough answers – and the clock is ticking faster than ever.

 

 

 

 

Refugee crisis, political turbulences, economic struggles brought on by austerity and Brexit. Katina Hristova explores the crisis that the European Union has found itself in.

 

"The fragility of the EU is increasing. The cracks are growing in size”, warns EU Commission Chief Jean-Claude Juncker. With Italy’s Government crisis finally being resolved and the country’s shocking rejection of NGO migrant rescue boats, it has been easy to detract from the political earthquake that the third largest EU economy experienced and the quick impact that it had on the Euro. But Europe’s problems go deeper than Italy’s political turbulences. A month ago, Spain, the fourth biggest Eurozone economy, was faced with a very similar crisis and even though the country now has a new leader, analysts believe that the Spanish instability is not over yet. With the shockwaves of both countries’ political uncertainty being felt on Eurozone markets, on top of migration pitting southern Europe against the north and as the UK marches on towards Brexit whilst Trump abandons the Iran Nuclear Deal, which could mean the end of the transatlantic alliance between the US and Europe, is the EU in serious trouble?

 

Why is it so serious?

Billionaire Investor George Soros is one of those people that can sense when social change is needed and when the current cultural and political processes are about to collapse. A month ago, in a speech at the European Council on Foreign Relations, Soros claimed that: “for the past decade, everything that could go wrong has gone wrong”, believing that the European Union is already in the midst of an ‘existential crisis’. The post-2008 policy of economic austerity, or reducing a country’s deficits at any cost, created a conflict between Germany and Greece and worsened the relationship between wealthy and struggling EU nations, creating two classes – debtors and creditors. Greece and other debtor nations had sluggish economies and high unemployment rates, struggling to meet the conditions their creditors set, which resulted in resentment on both sides toward the European Union. Back in 2012, the European countries that struggled with immense debt, malfunctioning banks and constant budget deficits and needed help from other member countries were Portugal, Ireland, Greece and Spain. In order to help them the creditors countries set conditions that the debtors were expected to meet, but struggled to do so. And as Soros points out: “This created a relationship that was neither voluntary nor equal – the very opposite of the credo on which the EU was based”.

Although Italy finally has a government, after nearly three months without one, the financial markets are apprehensive about what to expect next, considering the country’s €2.1 trillion debt and inflexible labour market. On 29 May, fearing the political crisis in the country, the Euro EURUSD, +0.6570%  slid to a six-month low, whilst European stocks ended sharply lower, with Italy’s FTSE MIB I945, +1.43%  ending 2.7% lower, building on the previous week’s sharp losses. Bill Adams, senior international economist at PNC believes that: “The situation serves as a reminder that political risk in the Euro area hasn’t gone away. Italy is not on an irrevocable road to anything at this point,” he said. “I think what is most likely is another election later this year, and what we’ve learned is that outcomes of elections are very unpredictable.”

Spain on the other hand has made huge progress since being on ‘EU life support’ when ‘its banks were sinking and ratings agencies valued its debt at a notch above junk, on a par with Azerbaijan’. Since receiving help, the country’s economy has been growing, unemployment is not as high and its credit rating has been restored. However, with the Catalonia separatism, and the parties, Podemos and Ciudadanos who have emerged to challenge the old duopoly between the Popular Party (PP) and the Socialists, the political uncertainty in the country is set to continue.

Greece has been in a permanent state of crisis for a decade now, with its current debt of 180% of its gross domestic product (in comparison, Italy's is 133%). In less than two months, on 20 August, the country is due to exit its intensive care administered by the European Central Bank and International Monetary Fund. The EU will then have to come up with a new debt relief offer on the $280 billion Greece still owes – which could be challenging, as the ‘creditors’ are not in a charitable mood.

In contrast, Poland and Hungary are financially stable, however, both countries seem to be in opposition to the EU with regards to immigration, the independence of the judiciary, ‘democratic values’ and freedom of the press. Both governments have dismissed EU plans to share the burden that the Mediterranean region carries in terms of migrants arriving into these countries. In addition to this, Hungary’s Prime Minister is promoting an ‘illiberal’ alternative to European consensus, whilst Poland has sided with the US and against its European partners on a range of subjects, including the Iran sanctions and Russian gas pipelines.

And of course, let’s not forget the EU’s list of unsolved issues – the main one being Brexit. With nine months until its deadline, the terms of Britain’s exit from the EU are nowhere near finalised.

 

Make the EU an association that countries want to join again

Today, young people across the continent see the European Union as the enemy, whilst populist politicians have exploited these resentments, creating anti-European parties and movements.

Since its establishment, the EU, an association that was founded to offer freedom, security and justice without internal borders, has survived many turbulences. Although the current crisis is based on a number of deep-rooted problems, odds are that these challenges will be overcome. To save the EU, Soros believes that it needs to reinvent itself via a ‘genuinely grassroots effort’ which allows member countries more choice than is currently afforded.

"Instead of a multi-speed Europe, the goal should be a 'multi-track Europe' that allows member states a wider variety of choices. This would have a far-reaching beneficial effect."

And even though he isn’t offering a proposition for a bill that someone needs to draft and pass as soon as possible, he has opened a conversation - a conversation about moving away from the EU’s unsustainable structure. “The idea of Europe as an open society continues to inspire me”, says Soros. And in order to survive, it will have to reinvent itself.

 

According to many reports, Italy’s ongoing political failure has potential to bring the Eurozone crashing down, which in turn could cause mass impact across the globe’s economy, both short term and long term.

In a recent turnoff events, both parties Five Star Movement and Lega Nord have been committed to the Italian government following a period of limbo since the March general election. Italy currently represents almost a fifth in the Eurozone economy and is feared as “too big to be saved.” Giuseppe Conte has been appointed the interim PM.

Below Finance Monthly has collected Your Thoughts in this financial debacle, summarising some points of expertise form top reputable sources across Europe.

Daniele Fraiette, Senior Economist, Dun & Bradstreet:

Italy’s new prime minister, Giuseppe Conte, will need to try and strike a balance between reassuring European partners about Italy’s permanence in the eurozone, and the 5SM’s and NL’s overt intolerance towards European Union rules on budgets and immigration.

In the weeks before the resolution of the crisis, Italian bond yields rose to levels only seen at the peak of the debt crisis in 2012, dragging yields on other peripheral euro-zone economies’ debt higher. The spread between Italy’s 10-year government bonds and Germany’s equivalent-maturity bonds also soared, passing the 330 basis point mark. The political vacuum seems now to have been filled; however, the spread remains at levels which signal significant market concerns around the country. The end of the ECB’s bond-buying is an additional factor of concern as they could prompt a significant increase in Italy’s borrowing costs.

Italy’s overall macroeconomic environment has improved remarkably over the past years: real GDP grew by 1.5% in 2017 and looks set to expand further in the 2018-19 period, the current account surplus currently stands at around 3% of GDP and its debt service cost has dropped to below 4% of GDP, down from above 6% before the introduction for the single currency. However, at 132% of GDP, Italy’s stock of public debt is huge, and the ongoing political turmoil poses a threat to the country’s stability. Indeed, should the political crisis morph into a sovereign debt crisis, debt costs would soar and debt service become unsustainable.

If Italy defaulted on its debt (which is not Dun & Bradstreet’s baseline scenario given Italy’s strong domestic investor base), the survival of the eurozone would be irreparably compromised. There is also a risk that concerns over a possible referendum on the euro, repeatedly contemplated by the 5SM and the NL but eventually scrapped from their election manifestos, could trigger a flight of deposits from Italian banks, many of which remain saddled with high levels of non-performing loans.

Although the darkest hour of Italy’s politics seems to be over, tensions between the Italian government and the EU, as well as within the government itself, are highly likely to persist; political uncertainty will likely remain elevated in the quarters ahead and the risk of early elections constantly looming.

Roberto Sparano, Globalaw:

After the longest political crisis in Italian history, a new cabinet of ministers was appointed on Saturday. Technically, the new government needs the confidence vote of both chambers of the Italian parliament, but it seems likely that the vote will go in favour of the odd alliance between the 5stars movement and the Lega.

In the closing moments of his BBC TV commentary for the 1966 FIFA World Cup Final, Kenneth Wolstenholme said "They think it's all over," but in reality it was not! This is, more or less, what is happening now. Most Italians are happy that it is over and we are back to normal, however, in realty this is only the beginning.

Local elections are scheduled for the 10th of June, and both the Lega and M5S will campaign on different and opposite barricades. Campaigns can easily turn ugly in Italy, and the first objective of the new government will be to survive these next few weeks without any major clash between the two parties.

In fact, the new local elections will be the first referendum against Europe and the Eurozone.

As Italians, we always have difficulty owning up to our responsibilities, that is the way we are, and we have become experts in the art of shifting the blame onto others. Germany has, for many reasons, been the perfect target since the end of WWII.

The notion of external control was actually one of the factors that convinced Italian lawmakers and politicians to join the European Union in the first place. This is because, if anything goes wrong, or is hard to swallow and unpopular, the blame falls on the EU as an external body- and obviously the Germans!

This may be a hopeless situation... but it is not serious, like in the 1965 movie directed by Reinhardt.

I do not think that the Eurosceptic have been strengthened from the last Italian elections. The truth is that most people are not ashamed to feel anti-EU (given that the EU has served as a punching ball and a symbolic cradle-of-all-evil over the past decades). Two non-traditional political movements are only going to cash in on this feeling.

Italy’s political climate will have a consequential effect on the Eurozone and the European Union. I am convinced that the Lega is aware that we cannot leave the EU or the Euro (I cannot speak for the M5S since I do not think they have any policy or line at all), but they are also aware that the other Euro partners cannot afford Italy’s break from the Euro or the EU.

The current anti-European feeling will undoubtedly be used as a bargaining chip for other purposes, for example, to stop immigration or, even better, to accelerate the process of moving immigrants from Italy. If Germany and the EU play this the hard way it could be fun to watch, although, as an Italian, it will be painful. On the flip side, it could be the perfect opportunity to change the EU, although, while Lega and M5S are calling for a new and stronger Europe, nobody knows (including Lega and M5S) what a “stronger Europe” really means.  My idea of a stronger Europe … I fear it is exactly the opposite of the idea of the Lega.

The situation is unpredictable, some of the measures that form part of the “Contract” between Lega and M5S could have a beneficial impact on our economy, although the Italian debt will skyrocket and in the long term, this would have a devastating effect.

The real problem will be the Italian State rating and the Italian bank rating. If the new government leads to a downgrading, the ECB will not be allowed to acquire our State bonds. Due to this, quantative easing measures will cease to help our growth, and the banks will collapse.

Italian economics are already not brilliant (that is lawyerlish for awful). We are the slowest growing European member, our private sector has never driven, and our banks … well our banks are declining.

We are already a supermarket for foreign corporations; Chinese, Indian, USA and other European companies have already acquired most of the jewels of the crown in terms of brand know-how, and excellence. Despite this, if anything goes wrong, we will become a discount or outlet!

On the other hand, our history shows that Italy always manages to survive, after all, on April 25th each year we celebrate the victory against nazi-fascism in WWII.

Giuliano Noci, Professor of Strategy and Marketing, Politecnico di Milano School of Management:

Following a week of political uncertainty in Italy, international financial markets are recovering well. Analysts expect that the announcement of a new government and the unlikelihood of fresh elections indicate that no further disruption will occur.

However, the root causes of how Italy landed in this particular political situation – where the young Five Star movement and Matteo Salvini’s League won more than half the votes in parliament – must not be ignored.

Both parties – although internationally scorned for Eurosceptic views – were able to gain the support of the Italian population, playing on both their emotions and feelings of insecurity. Both delivered well-designed storytelling campaigns via social media rather than mainstream media – a technique neglected by other parties.

The population’s insecurity has two main manifestations. Firstly, the feeling that the EU did not do enough to help Italy during the mass immigration of refugees of Syrian war. Secondly, the sense that the EU is failing Italy in important economic areas. Five Star promised a basic income for the unemployed whilst they train and upskill, and the League pledged to reduce the burden of fiscal taxation on companies by introducing a flat tax system.

So, are the parties reaching the core of Italy’s problems and setting out the right solutions? This is a question which deserves careful consideration. In my opinion, the parties were wrong to use aggressive tactics to fuel the debate about whether to remain in the EU. However, they were very right to suggest that the European Union must significantly change the rules of the game. We are seeing problems not only in Italy, but in Greece, Spain and perhaps even France in the imminent future.

These are signs that the Eurozone is not working, which is most likely because the Euro project is incomplete. Although we have a unique currency, there is no unique system for managing the risk of banks or the unbalanced, heterogenous economic systems of each country.

In the long run, a lack of reforms will create a bigger problem for the Eurogroup than Italy’s political situation. Change must come from within the EU following this situation and discussions of structural reforms in the banking sectors, as well as a safety net fund, must begin.

If no change occurs, the 2019 EU elections are likely to be just as complex as Italy’s.

Stephen Jones, Chief Investment Officer, Kames Capital:

Following Macron’s victory, the eurozone was the ‘good news’ story of 2017 as the area’s economy burst into life and global investors returned in droves. This year has seen economic momentum collapse sharply and, perhaps more than coincidentally, populist pressures have brought the fault lines back to the fore. For the moment this is an Italian issue but these pressures exist in most eurozone nations.

Equity markets have weakened on these changes but Italian worries have largely reinforced a trend already in place. Elevated ratings, and analysts offering a very rosy earnings outlook, left markets vulnerable to poor news and a variety of geo-political developments have emerged to offer that challenge; fat profits were there to be taken.

These risk markets setbacks have, however, taken the steam out of rising short rate and long yield forecasts and will probably succeed in ensuring that quantitative easing is continued in Europe for longer than might otherwise have been the case. When the dust settles, this should underpin equity markets, allowing progress to be made afresh and from safer levels; the positive earnings outlook offered by analysts have good real-world support.

However, to be clear, this supposes that Italy stops short of turning a drama into a crisis. Those of us of a certain vintage know well enough that Italian politics are not to be trusted.

Jordan Hiscott, Chief Trader, ayondo markets:

I was recently asked If I thought the current situation in Italy, in regard to potentially leaving the EU, was a black swan event. My response was no; a grey swan would be a much more suitable adjective to describe Italy in its current state. The ultimate definition of this would be a risk event that can be anticipated to a certain degree but still considered unlikely. A black swan being an event that is not anticipated in the slightest.

Italy has the third largest economy in the Eurozone and this political turmoil, of once again populist vote, threatens the unity of the bloc. But the situation is further exacerbated by the perilous state of Italian banks. Indeed, this is nothing new and they have been in the poor shape for a while, and the only surprising part to me is that the market hasn’t been paying attention to this, until now.

The culmination of the situation is we now have a perfect storm. Another type of a coalition government has been formed and the cynic in me looks at Italian politics on a historical basis and questions if this is this indeed the end of an unstable ruling government or in the colloquial sense, papering over the cracks? This is coupled with a worsening financial situation for the nation’s major banks. The move on Italian two-year treasury yields last week was nothing short of astounding, with the range and volatility more akin to a cryptocurrency than of a bond from a first world country.

The Italian stock market is now almost completely unchanged on a five-day basis, given it was down over 7% at once stage last week.  In addition, to confirm this, EURUSD has moved from a low of 1.1520 last week to 1.1750. The next move will be key, but from my perspective I’m finding it hard to feel positive, even from a mean reversion perspective, for the pair, given the length and weighted negative implications surrounding Italy at present.

April LaRusse, ‎Fixed Income Product Specialist, Insight Investment:

In contrast to the European sovereign crisis, Italy is now an idiosyncratic story. Across Europe, the previous crisis hit countries such as Spain, Greece and Portugal are all on an improving path, reaping the rewards of structural reforms implemented after the crisis. In Italy, pension reforms were certainly a positive step, but the country failed to undertake the deeper changes needed to sustainably raise potential growth.

The two key parties are proposing a range of expansionary fiscal measures, cutting both income and corporate taxes and proposing a minimum citizens income of €780 per month. Although more controversial measures, such as asking the European Central Bank (ECB) to write off up to €250bn of Italian debt, have been dropped, investors will be well aware that these were considered serious policy proposals by elements of the new government.

Debt/GDP will start to rise once again and credit rating agencies are likely to start to downgrade Italian debt, in contrast to the rest of Europe where credit ratings are improving. This leaves us cautious on Italian spreads, especially in an environment where we believe the ECB will be winding down its quantitative easing purchases.

David Jones, Chief Market Strategist, Capital.com:

There is a familiar feel to the catalyst behind the increased levels of volatility that traders and investors have seen across all markets, leaving some wondering if we are going to have another Eurozone crisis along the lines of that involving Greece from 2016. At this stage that does seem like an overly-pessimistic view, but it’s not hard to understand why safe-haven buying is the order of the day.

An oft-repeated phrase from past Eurozone crises was “kicking the can down the road”, referring to deferring that country’s debt obligations. This time around it feels as if the political can, rather than the financial one is being kicked into the long grass - and this is what is spooking markets. One of the main worries for traders is another election in a few months could result in a populist government that wants to renegotiate Italy’s debt with the EU. This is running at around 130% of the country’s GDP - the second highest level after, you guessed it, Greece.

The obviously immediate casualty was the euro. It had hit a three-year high against the US dollar as recently as February this year. Since then it’s dropped back by around 8% to its lowest level since last July. There is a double-whammy behind traders’ decisions to sell euros. Clearly any uncertainty about Italy’s debt repayments and the country's commitment to the single currency doesn’t inspire confidence - plus this year already we have seen a resurgence in popularity for the US dollar after its slide in 2017 was the worst performance for more than a decade. It can always be argued that the market reaction is overdone - but whilst Italy’s political future remains uncertain, it’s a brave trader who calls the bottom of this slide.

European stock markets have also been hit. The Italian market is the obvious biggest casualty and is now down by 13% in just one month - but the German and UK markets are also lower as investors adopt the familiar “risk-off” approach at the slightest whiff of a possible euro crisis. Many world stock markets already had some fragility when it comes to investor sentiment after the sharp falls seen in February and an ever-increasing oil price - it is difficult to see these recent losses being made back quickly.

While some sort of “dead cat bounce” can’t be ruled out in the days ahead, as long as this political can-kicking continues, then investors are likely to remain cautious about taking on risk - so it could be a summer of European-inspired volatility across all asset types.

Tertius Bonnin, Investment Analyst, EQ Investors:

This had been a slow moving car crash in which the signs have been there for all to see; populist parties were the clear winners of the March election (nearly three months ago) and the two largest parties, the Five Star Movement and the Northern League, had been negotiating a framework for co-governance since. Surprisingly, a number of market participants had expressed that they didn’t anticipate the “change” in attitude of the two famously Eurosceptic parties towards the euro. It should be noted that Italy isn’t new to political uncertainty, with Italian voters seeing 62 governments since 1946.

The Italian President’s veto of the proposed finance minister, Paolo Savona, and the subsequent increase in the probability of another election caused a kneejerk reaction in the markets on Monday. These moves spilled into the Tuesday session as the Monday was a bank holiday in the US and UK. Trading volumes on the Monday were therefore relatively thin in comparison. Tuesday saw huge spikes in key barometers of relative risk such as the Italian-German government bond spread (difference in yield) and the Italian two year bond yield. Global banking stocks, considered most sensitive to a change in economic activity, also sold off. Despite the so called PIGS (Portugal, Italy, Greece and Spain) taking significant knocks, investors in relatively safe government bonds (German bunds, UK gilts and US treasuries) benefited from a “flight to safety” whereby panicked investors moved capital into less risky assets.

There had briefly been calls by the Five Star Movement’s leader to impeach President Mattarella. Under Article 90 of the Italian constitution, parliament may demand the president to step down after securing a simple majority. Italy’s constitutional court would theoretically then decide whether or not to impeach Mr Mattarella. Given the president had not violated any Italian laws, this route appeared relatively futile. On this impasse, the populist coalition appeared to have collapsed and the market took a collective sigh of relief as the Italian President moved to appoint ex-IMF director Carlo Cottarelli to run a short-term technocratic administration until the next set of elections. It should be noted that the Five Star Movement, the Northern League and Berlusconi’s party all said they would have vetoed this.

It is likely this development fed into the Northern League’s decision to call for fresh elections at a political rally, having seen an uplift of circa 8% in opinion polling. Investors once again panicked that the risk of future elections had the potential to not only reinforce the populist parties’ positions in both parliamentary chambers, but become a de facto referendum on Italy’s euro membership. After 2017 being relatively benign year for political risk, investors had been caught asleep at the wheel in terms of pricing in uncertainty in the political sphere.

By Friday the situation had turned around once again after the Italian President provided more time for the Five Star and Northern League parties to form a government; the former designate Prime Minister Giuseppe Conte was sworn into office while the key Finance Minister role went to a seemingly more pro-European, Giovanni Tria, who headed the Economy Faculty at Rome’s Tor Vergata University. Paolo Savona, the former candidate vetoed for this position will now serve as Minister for European Affairs in a sign that the new administration’s focus will be on fiscal expansion plans and rolling back reforms, rather than investor angst around fresh elections and euro membership. This rollercoaster ride in political uncertainty has been tracked by the spike in yield of the supposedly risk-free Italian government bond.

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Following talks in Brussels, the Greek government has agreed to unlock a further €10.3bn (£7.8bn) in loans from its international creditors, who have also agreed on easing the debt burden of Greece which totals €321bn (£245bn) - worth 180% of the country’s annual economic output. The tranche of bailout funds will be split into two payments: €7.5bn in June and €2.8bn in September. The European officials plan to extend the repayment period and cap interest rates.

However, the debt relief plan is far from the ‘upfront’ debt relief that The International Monetary Fund (IMF) has demanded. Poul Thomsen, director of the IMF’s European programme, said the IMF had made “a major concession”. “We had argued that (debt relief measures) should be approved up front and (now) we have agreed that they should be made at the end of the programme period.”

Germany was in opposition to the ideas about the debt relief, expressing beliefs that a debt relief could not be considered before the end of Greece’s current €86bn bailout programme in mid-2018.

"We achieved a major breakthrough on Greece which enables us to enter a new phase in the Greek financial assistance programme," said Jeroen Dijsselbloem, President of Eurogroup. He added that the package of debt measures would be "phased in progressively". This review was the first one under Greece's third eurozone bailout, secured in August 2015, after which Greek Prime Minister Alexis Tsipras called a snap election. This move happened only two days after the Greek parliament approved another round of tax increases and spending cuts, that were demanded by the creditors.

pieCHARTEconomic growth in the Eurozone, which should achieve 1.4% in 2015 and further to 1.8% in 2016, leading to another good year for Central and Eastern Europe (CEE) in 2015, according to the latest CEE Quarterly report by UniCredit Economics & FI/FX Research.

Exports from the region stand to benefit in particular from the economic recovery in the Eurozone, while the ECB's quantitative easing should stimulate capital flows and keep financing costs low at the same time.

According to UniCredit, the favourable external environment also offers local central banks the opportunity to keep interest rates at record lows for an extended period of time, prolonging the accommodative monetary stances in place. Low financing costs could provide some scope for fiscal support, especially in countries where government deficits and debt are at moderate levels. However, not all countries in Central and Eastern Europe will be able to benefit to the same extent from the favourable conditions.

"Countries with solid fundamentals and advanced reforms will draw the lion's share of the benefits from the current situation," said Lubomir Mitov, CEE Chief Economist at UniCredit.

These countries (EU-CEE) include the Baltic States, Poland, Slovakia, Slovenia, the Czech Republic and Hungary, which joined the European Union in 2004, as well as Bulgaria and Romania, which became EU members in 2007.

These export-focused EU-CEE countries should be able to utilise their competitive advantages and close economic ties with Germany to the fullest extent. Real GDP growth should accelerate to 2-3% this year as a result, except for Poland, where growth will exceed 3%.

UniCredit did extend a caveat to its positive forecasts, citing that the interest rate hikes expected later this year from the US Federal Reserve could exert an adverse impact on global risk appetite and result in stagnation or a reversal in capital flows to the CEE countries.

EUAnnual consumer price inflation across the Eurozone climbed up to zero in April 2015 after four months of consecutive declines, Eurostat has announced. However, there is still much to do. Even at zero, the rate of inflation remains well below the European Central Bank's (ECB) target of at or below 2%, with the weak performance owing largely to declining energy prices. Meanwhile, the unemployment rate stayed steady at 11.3% in March.

According to the Centre for Economics and Business Research (Cebr), this should give the ECB a chance to catch its breath after a bumpy start to the year. Its quantitative easing programme (QE), launched to address the currency union's poor economic performance, is showing results. Much has happened through the currency channel, with the euro depreciating sharply against major currencies since the policy was announced. Consumers are also starting to feel the benefits: confidence across the Eurozone is up and retail sales are growing at their fastest pace since 2005. This has caused some to think that the ECB may terminate QE earlier than the currently suggested timeframe of end 2016.

The last two years suggest that trying to gauge the economic climate a year ahead can be tricky. Cebr remains on the cautious side. “The Eurozone job is definitely not done yet, let alone well done. Germany is carrying on a decent path to recovery but the union's second-largest economy, France, is still far from finding its way there. Much-needed labour market reforms have been absent from the picture, and, with the presidential election season approaching fast, appetite for pressing on with unpopular measures is bound to decline,” Cebr said in a statement.

The independent economics consultancy continued: “Conditions seem brighter in the South, especially in Iberia. Looking ahead to the rest of the year, the Eurozone's southern periphery will most certainly enjoy an uptick in the summer as tourist season kicks in. Receipts from tourism should be especially strong this season given the weakness of the euro and geopolitical tensions in regional competitors such as North Africa. But the fundamentals remain weak.”

Greece, while closer to a deal now after a new reforms package emerged from the new negotiating team in Athens earlier this week, is still at a very fragile state. Its banking sector is heavily dependent on the ECB's willingness to continue providing funds through the Emergency Liquidity Assistance mechanism. In 2015 thus far, around €30 billion of deposits have been withdrawn from Greece's banks. And non-performing loans are at 35%, much higher than 2012 levels of 25%. The banks remain systemically sound: capital adequacy ratios at above 12% are exceptionally high. But any “accident” in the negotiation process would quickly make banks lose deposits. It will then be up to the ECB to decide the country's fate.

Ashish Misra, Lloyds Bank Private Banking

Ashish Misra, Lloyds Bank Private Banking

March saw an overall average asset class sentiment reach a high, according to the monthly Lloyds Bank Private Banking Investor Sentiment Index. With continued improvement in overall asset class sentiment, net sentiment increased for seven of the ten asset classes surveyed with only a modest decline for the other three, leading to its highest overall score since June 2014.

However, in contrast to asset class sentiment, actual asset class performance decreased for nine out of the ten asset classes since last April.

Despite receiving the most negative sentiment of all asset classes (-33%), Eurozone shares recorded the largest positive month-on-month gain for the first time. With net sentiment increasing 13 percentage points, Eurozone shares also saw the highest increase for the asset class since the survey began in March 2013.

Ashish Misra at Lloyds Bank Private Banking, said: “The continued improvement in asset class performance paints a positive outlook for investors. Most notable is Eurozone shares, which has gained significant momentum, despite still displaying a highly negative sentiment. This could reflect the improvement in sentiment on account of the commencement of quantitative easing by the European Central Bank and some improvement in the overall macro-economic backdrop for the region despite ongoing challenges in the periphery.”

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Gold was the biggest net loser in March, dropping 5 percentage points compared with February and saw its first negative swing since the start of the year.

Three out of the four sterling-denominated asset classes recorded a positive performance with UK shares rising 7 percentage points, UK corporate bonds rising 4 percentage points and UK government bonds rising 1 percentage points. UK property saw a 3 percentage points fall in sentiment, signalling its second dip this year.

In terms of an annual change, six of the asset classes recorded an increase, with Japanese shares (+28%), UK property (+17%) and UK government bonds (+10%) seeing the largest increases. Commodities (-38%), Gold (-16%) and Eurozone shares (-9%) were the worst performers.
All of the four sterling-denominated classes saw an increase in terms of annual change with UK corporate bonds and UK shares seeing an increase of 7% and 2% respectively.

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