Five hundred years ago Martin Luther nailed his ‘Ninety-Five Theses’ to the door of All Saints’ Church in Wittenberg. The good people of this modest city in Saxony could not have known that this act by a troubled Augustinian friar would convulse Europe for centuries. Luther’s complaints in 1517 against the excesses of contemporary Catholic practice marked the start of the Protestant reformation.
The Thirty Years War that followed engulfed almost every nation on the continent, but most of the pain was inflicted on Germany. Some populations in its city states were decimated. After two more catastrophic wars in the 20th century, all Europeans should be thankful that current German politics is rather staid. There are no former clowns, serial philanderers, crypto fascists or reality TV personalities leading political parties with any chance of power.
The federal elections in September pit Angela Merkel, a chemist by training, against Martin Schulz, a former bookseller. Schulz’s most recent job has been president of the European parliament. Of late European elections and ill-conceived referendums have been the triggers for investors to signal their concerns about the prospects for the euro. There is nothing to fear in Germany.
That should be sufficient to ensure that the current strength of the euro persists and buys policymakers time to reap the benefits of ultra-loose monetary policy. When European Central Bank president Mario Draghi made his comment in July 2012 that he would do “whatever it takes” to save the euro, the dynamic of European markets changed. During the eurozone crisis selling peripheral bonds had become a one-way bet. Increasing yields led to greater austerity, deepening economic recession. Crises were market led.
Since then the aggressive adoption of quantitative easing has successively pushed yields down. The ECB has tamed the bond vigilantes. Instead, the currency has become the lightning rod for investor anxiety and this has been focused on elections, particularly the fear that anti-euro populist parties would increase their sway. The heavy defeats of Geert Wilders in the Netherlands and Marine Le Pen in France have allayed fears of redenomination risk, for now.
The election of Emmanuel Macron to the French presidency has put an economically literate pragmatist at the centre of European power. Even Brexit could be seen as a positive for the euro. The UK was never likely to join the single currency, which seemed like a haughty dismissal of its credibility and viability, but was a big voice in Europe. Now the Franco-German core of the eurozone is driving the project without the distraction of a sulky, semi-detached neighbour.
Political risk in Europe has diminished at the same time as economic prospects have brightened. Growth accelerated to 0.5% in the first quarter. Forward-looking indicators, such as purchasing manager indices (PMIs), point to that momentum continuing. Positive economic surprises are running ahead of the UK and US. Analysts have been upgrading their earnings estimates for eight consecutive months, but companies are still beating forecasts by a ratio of 2.5:1.
It is Europe’s core that is most robust. The Ifo measure of German business confidence is at its highest level since the fall of the Berlin Wall. France’s PMI is at a six-year high of 57.6. But importantly the rest of continent is not far behind, the Europe-wide PMI is 56.8. Unemployment is still high at 9.5%, but that is the lowest level for eight years. This makes setting policy more straightforward for the ECB.
For the moment, a one-size-fits-all monetary policy is not creating serious imbalances. German house prices have risen by around 60% in cities such as Frankfurt. However, this is largely a reflection of a shift in consumer preferences from renting to buying and historically low interest rates.
The biggest cloud on the horizon is Italy. Elections are due there in March next year, and the populist, anti-euro Five Star Movement is leading the polls. Italy has government debt equal to 132% of GDP and debt service costs only exceeded by Greece in the eurozone. The country has seen little benefit from the euro, with no real-terms growth and stubbornly high unemployment.
However, the strength of the core is good news. Italy runs a positive trade balance and its biggest export markets are Germany and France. The strength of the euro should be offset by increased demand from confident consumers in Paris and Berlin. The euro is not out of the woods. But if Macron and the next German chancellor can push forward a reform agenda, it may prove more durable than Anglo-Saxon sceptics think.