Domestic demand remained sluggish, but private consumption and investment continued to grow. Thus at the end of 2004, the carry over effect for 2005 reached only 0.4 per cent.
This year will see another year of weak economic activity in the euroland. Support from external trade is currently fading away due to oil prices and the global slowdown. Domestic demand will remain moderate without strong external demand and acceleration in consumption. There is no major support to expect from policy mix, as fiscal policy reached its 3 per cent deficit target in the three major countries and as the low level of short rates has lasted for 21 months.
Positively, the focus on productivity gains and balance sheet repair in the corporate sector should fade progressively, leaving room for greater capacity investment. As a result of restructuring in the non-financial corporate sector, gross operating surplus as a percentage of national income has risen.
A key driver in Europe’s fortunes has been the European Central Bank’s monetary policy. With a combination of slow growth, a strong euro and decelerating inflation, the ECB is unlikely to raise rates this year. Indeed, expect a benign inflation environment in 2005, with consumer price inflation averaging 2 per cent.
Despite continued energy price strength, overall inflation has remained muted. The lagged effect of the rise in the foreign exchange value of the euro will also help tame import prices.
Unfortunately, while the fundamentals are improving, which should prove positive for European stocks, equity performance remains tied to movements in the oil price. Supply is currently near capacity and demand shows no sign of abating.
However, Europe, remains a favoured region. Earnings growth this year is expected to be 10 per cent, which takes the multiple down to 12 times, fairly cheap in a global context.
Franz Wenzel, senior strategist, Axa Investment Managers
