What risks could derail Europe’s positive momentum?

The outsider’s perspective on Europe has been transformed since the beginning of the year. The economic outlook on the Continent continues to improve at a rapid rate, while the feared rise of the far-right has failed to materialise. Significant flows are now returning to the much-maligned region; with investor confidence recently hitting a 10-year high.

Despite the European economic landscape appearing stronger than 12 months ago, there remain three risks investors must continue to watch closely…

Divergent economic prospects

A major challenge facing the European economy is the divergence of economic data within the region. While Germany’s economy is at a late stage in the cycle, with full employment and sustained growth, far ahead of Italy and Spain, which continue to struggle with high unemployment levels, albeit in the context of recovering growth and hard-won trade surpluses.

Because of these divergent fundamentals, some economies are more attractive from an investment perspective. One country to have recently caught our attention is Ireland. It has one of the most flexible economies on the Continent and has far better demographics than the rest of Europe – factors which have contributed to sustained high growth. The only headwind is Brexit, which is still very much an unknown.

We have recently participated in the IPO of Greencoat Renewables and took a stake in the Bank of Ireland, both of which should benefit from the country’s positive domestic economic momentum.

Draghi’s policy dilemma

The eurozone’s divergent economic data presents clear challenges for the European Central Bank (ECB) and Mario Draghi. The maturity of the German economic cycle means it is primed for a tightening of monetary policy, while countries on Europe’s fringe have much higher levels of indebtedness and would benefit from continued accommodation.

This conflict has resulted in an uneasy middle ground, where the ECB has announced it will taper its quantitative easing programme, without raising rates at the same time. However, as Draghi nears the end of his term, the influence of France and Germany on central bank policy could increase as candidates from the two nations lead the field of successors.

Political headwinds remain

The primary concern surrounding Europe earlier this year was the potential rise of far-right politics. While the overall election results in France and Germany seemed to calm this nervousness, a far-right party was able to win seats in the German parliament for the first time in half a century. In addition, Austria is now governed by a coalition featuring a far-right minority.

Upcoming elections in Italy do not promise much in the way of stability, with projections suggesting power will be won by a right-wing anti-European alliance. While the involvement of former leader Silvio Berlusconi should stem some of this government’s disruptive potential, the projected outcome suggests the far-right pressure on European politics has not ended as conclusively as markets currently suggest.

Finally, Brexit concerns are intensifying, which could impact all economies across the region. It is still unclear if a deal will be made and negotiations could be extended further, which could potentially create headwinds for years to come. Because of this uncertainty, we are favouring defensive sectors better able to withstand any economic disruption – including telecoms and utilities.

Chris Hiorns is manager of the EdenTree Amity European fund