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Europe’s central bank set to lead the path to prudence

Although many governments will keep pushing loose fiscal policies, capital repricing is inevitable ? probably led by the ECB. That lead should favour the euro and European bonds, at least for a while

June?s European Parliament elections confirmed two things. First, public discontent is so high that the EU?s new constitution will be rejected. This will leave the EU without the institutional framework to make vital economic decisions. Second, the elections showed that incumbent European governments (especially those that supported the US invasion of Iraq) will soon be thrown out. There is deep, widespread, seething resentment about government policies and posturing.

Europe?s political thrust will now be focused more on building itself and its allies into a counterweight to US primacy. A leaderless multipolar world seething with power rivalries is a breeding ground for beggar-my-neighbour economic policies and protectionism by populist governments. That will not be a good world for investors.

Some of these poor conditions for investment are obvious: lower growth, higher inflation and slimmer profit margins. Second-round investment consequences include government sponsorship of inefficient national champions, the survival of weak national corporations and sectors and restrictions on capital flows.

In the EU, the European Central Bank will have to cope with continuing big budget deficits and lack of economic reform. This will keep inflation high and growth low. The ECB will prioritize inflation control with higher real interest rates.

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