There has been a lot of commentary surrounding Europe in recent weeks. In this article, we explore the main issues that require consideration.

1. Quantitative easing

The European Central Bank (ECB) launched quantitative easing (QE) as expected. It plans to make purchases of 60 billion euros per month until at least September 2016. The move is unambiguously positive for European equities. When you combine the low bond yields and lower currency that may flow from QE, lower oil prices, low relative valuations and gradually improving credit dynamics, all things seem to point to a better outlook for Europe and European shares. Yes, structural reforms are still needed, but at least the cyclical outlook is good.

2. Switzerland removes its ceiling

The recent decision by the Swiss National Bank (SNB) to remove its currency cap with the euro saw the Swiss franc spike as much as 41% against the euro. The cap was introduced in September 2011 as Swiss policymakers tried to prevent their currency from becoming too strong against the euro. The move– which caught out many foreign exchange traders and forced several brokers to collapse – is a negative for the Swiss economy as it makes it less competitive relative to the Eurozone. In saying this, there is a danger in exaggerating the impact. Firstly, the decision to remove the currency cap was offset by even more negative interest rates in Switzerland. Secondly, while the Swiss franc is is up against the euro, the euro has been falling against other currencies. As such, the blow to the Swiss economy is not nearly as great as feared. Beyond Switzerland, there is minimal impact globally except to highlight the pressure that European economies are currently under in the face of monetary easing. Perhaps this is a good thing as it adds to confidence that a sustained bout of global deflation will be headed off.

3. Greece election

With Greece back in the headlines after the election win of the Coalition of the Radical Left (known colloquially as Syriza) it’s natural to wonder whether we are going to see a re-run of the Eurozone crisis that roiled global financial markets in 2010-2012. However, much has changed since 2012 and there is a long way to go yet before a Greek exit from the euro will occur, if at all. Another election cannot be ruled out as it’s still not clear how stable the new coalition will be. Assuming the coalition holds, the next step is negotiations regarding the ongoing debt support and reform program for Greece. Reaching an agreement could take some time and will likely be the source of financial market volatility in the months ahead. In summary, other peripheral countries in Europe are now in better shape as are the defence mechanisms – including ECB QE – than was the case in 2010-12.

What it means for investors?

While there will be bouts of short-term uncertainty for Europe, overall we don’t see a return to the Eurozone crisis. More broadly, there is a strong case to overweight Eurozone equities as valuations are relatively cheap and liquidity is positive. However, with the ECB easing monetary policy at a time when the US Federal Reserve is gradually edging towards rate hikes, and Greece throwing in some short-term uncertainty, the euro is likely to fall further against the US dollar. Against the Australian dollar, the euro may also slip - but with the Reserve Bank of Australia also set to ease further, any fall here may be limited.

Final thoughts

One of the key risks for Europe this year is the political drift to the extreme left, extreme right and associated anti-euro sentiment. Given the recent turbulence, we expect the intensity of the political angst to subside somewhat as the economy improves over time. In saying this, investors should not dismiss the risks entirely. There will be a number of other elections this year (notably in Spain) which will produce more news headlines and invariably some jitters along the way!

About the Author

Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

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