Euro-Area Economy Shines Through in Year of Political Strain

(Bloomberg) -- Even as Catalonia serves a reminder that political risks remain, the euro area’s year of living dangerously is turning out well for the economy.

On track for the strongest expansion in a decade and with consumer and business confidence at the highest since before the financial crisis, the 19-nation currency bloc is emerging as fertile ground for dealmakers, investors and executives.

“The wind is well and truly back in the sails of Europe,” said Simon Wells, chief European economist at HSBC Holdings Plc. “The question for investors I suppose is: can this continue?”

The upbeat economic outcome for 2017 wasn’t at all certain at the start of the year, when the shockwaves from votes for Brexit and Donald Trump were prompting warnings that the euro area would be the next to witness a populist surge that could splinter the currency bloc.

Catalonia’s illegal independence referendum on Sunday, which could see separatists make a unilateral declaration as soon as this week to split the region from Spain, showed that the risks are far from over.

Yet they have largely abated. Dutch populists were defeated in elections. German Chancellor Angela Merkel has to deal with a rise in support for the far right but she’s still readying for a fourth term in power. Newly-elected French President Emmanuel Macron is pushing a reform program, and fellow European Union leaders are planning deeper integration.

“The period of confusion may cause a dent in Spanish economic sentiment,” said Holger Schmieding, chief economist at Berenberg in London. “For the euro zone as a whole, the possible Catalan impact will probably be too small to make a noticeable difference.”

The European Central Bank forecasts an economic expansion of 2.2 percent this year, enough to persuade President Mario Draghi to consider slowing the institution’s extraordinary monetary stimulus. The Governing Council is slated to take that decision as soon as next month.

A purchasing managers survey published Monday confirmed that private-sector manufacturing activity accelerated last month, and showed factories scrambling to add staff. Unemployment held at 9.1 percent for August, slightly weaker than economists estimated -- and more than twice as high as the U.K. or U.S. -- but still the lowest since 2009.

Mergers & Acqusitions

Investors have responded by pushing the Stoxx Europe 600 up more than 7 percent this year, headed for the strongest gain since 2013. European takeovers have jumped 41 percent to $526 billion, offsetting a slowdown in U.S. deals, according to data compiled by Bloomberg.

Consumer transactions --- such as French lensmaker Essilor International SA’s purchase of Luxottica Group SpA, the producer of Ray-Ban sunglasses -- are leading the increase, reflecting growing optimism that job creation will boost household demand.

“Confidence is rising,” Marco Settembri, head of Nestle SA’s European business, said on Tuesday. “People are more confident to spend.”

Politics could still get in the way, and on a larger scale than Catalonia. Italians will vote to chose their parliament next year, with the euro-skeptic Five Star Movement set to make a strong showing. Merkel may have won the German election but her party still had its lowest share of the vote since 1949 as the far-right Alternative for Germany made gains.

That might throw a spanner in the works for Macron’s vision for overhauling the world’s largest trading bloc, where Germany’s cooperation -- from setting up a common euro-zone budget to potential harmonization of corporate taxes -- would be essential.

Euro Upside

The brighter economic outlook has also helped to push up the euro, which has risen almost 12 percent against the dollar this year and nearly 6 percent on a trade-weighted basis. The single currency has stabilized in recent weeks -- and fell more than half a cent after the Catalan referendum to trade around $1.1740 -- but the upward trend could reassert itself.

That’s worrying for the ECB because it depresses import prices and so curbs inflation, complicating its discussion on whether to start paring back on its asset-purchase program. It also makes exports less competitive, an issue for countries such as Italy that rely heavily on foreign sales and haven’t quite healed the wounds from the recent crisis.

HSBC estimates for every 10 percent jump in the trade-weighted euro, exports fall by 5 percent, and says net trade is going to be a drag on growth.

Bloomberg Intelligence predicts the expansion will slow slightly in the third quarter and decelerate further into the end of the year as the economy approaches its potential, according to BI economist Maxime Sbaihi. The ECB itself forecasts a slowdown to 1.8 percent in 2018 and 1.7 percent in 2019.

One warning sign? An unexpected decline in German business confidence for a second month in September. The region’s biggest economy also saw unemployment fall to a new record low last month -- at 5.6 percent -- but even it is struggling to lift wages and inflation.

“We probably are right around the peak,” said Jack Allen, an economist at Capital Economics in London. “But that’s not to say that we don’t think that things will continue to get better. Unemployment will keep on falling, gross domestic product will also keep on rising and, at least by euro-zone standards, the economy will continue to expand at a decent rate.”

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