The long road to recovery

22 Aug 2014

Greece’s successful first bond auction in four years, Ireland’s improved debt ranking and Portugal becoming the second eurozone state to exit its international financial bailout, all breathed life back into Europe’s peripheral economies earlier this year. But, more care and time is required before the region is back to full health.

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Greece has a general election in two years and has already had experience of more extreme parties making gains in the polls. Portugal’s ruling coalition faced a constitutional crisis in 2013 but agreed to stop the in-fighting while the country navigated its programme of reforms. Now that is finished, it is likely the gloves will come off and pragmatism will not be allowed to get in the way of politics.

Inflation-linked proxy assets

Some of this may be unavoidable as demand is low within Europe, so if global growth weakens this will be bad for European markets. And if anyone puts up rates sharply, and this is anticipated not only here but in the US, this will increase spreads in Europe.

Helen Roberts, lead investment policy adviser at the National Association of Pension Funds (NAPF) says that although US GDP has been disappointing and signals from the US have been mixed, risk appetite is up, witnessed by the positive returns on assets in the first half of the year. In recent weeks however, pension schemes have been taking a breather from adding more risk to their portfolios.

“A clear area of interest for pension funds over the last year or so has been inflation-linked proxy assets such as social housing, infrastructure and property. These assets are attractive as they yield more than gilts and have an inflation component that is linked to pension liabilities,” says Roberts.

In Europe, Roberts says the ECB will do whatever it can to support growth and inflation with the door remaining open to some form of quantitative easing (QE) if need be. Interest rates in Europe are likely to stay low for a prolonged period. Nervousness across the periphery has increased in recent weeks on the back of the Banco Espirito Santo problems, although Roberts does not believe this is a catalyst for an imminent escalation of problems.

However, she says that more needs to be done to prepare the periphery for a return to full health: “TLTROs may be enough to avoid the debt/deflation spiral, but proper reform is still required in the periphery markets.”