Western Europe’s Five Events to Watch in 2014

Progress toward reform in the eurozone looks unlikely in 2014. The region will continue to suffer from the lack of bank lending that contributes to an extended recession. Low growth potential could be exacerbated by uncertainty. Because potential for growth is low in 2014, companies will have little room for error when striving to meet or exceed performance targets. As businesses look to outperform in Western Europe this year, executives should monitor the five events that could disrupt the status quo:

1. Austerity fatigue erupts into civil unrest

Scenario: Unyielding austerity policies are fueling extremism – both on the right and left, politically – ahead of the May 2014 European Parliamentary elections. While an anti-EU European Parliament is unlikely to dismantle the institution, European growth would still be stalled as a result of delayed policymaking and increased political uncertainty. Furthermore, strong results for Eurosceptic parties could motivate a mainstream uprising in reaction to the European body’s tilt away from their ideals

Companies should watch for high unemployment that will gradually decrease social acceptance of austerity, and high levels of political risk that would increase bond yields and foretell a possible return to crisis in Europe

2. Low price growth hits demand and ages

Scenario: Low inflation – the result of weak business demand – combined with high unemployment and declining nominal wages could cause consumers to delay purchases as they expect further price declines. Retailers would be forced to slash prices, leading to declining profits, lower wages, and households struggling to meet fixed loan repayments because of falling salaries

Companies should watch for the continuation of low business demand and production. If the ECB cuts interest rates amid low economic growth, you should plan for a low inflationary environment to influence demand for your products

3. Results of bank stress tests call for further deleveraging

Scenario: The ECB, which has been credited with rescuing the euro by calming markets, could end up unleashing the next panic if it conducts a review of banks that is seen as overly rigorous. While bank stress tests are necessary for a sustainable eurozone recovery, very strict scrutiny would require banks to maintain more capital on their balance sheets, resulting in a further tightening of credit to businesses and households. Germany’s Landesbanken, medium-sized regional banks, are among the least capitalized in Europe and thus are most vulnerable to recapitalization; central and eastern European countries could also see a tightening of credit

Companies should watch for a failure of any country’s banks to meet capital requirements in ongoing and more rigorous bank stress tests. As the results of these tests are released in November 2014, prepare for bank for sovereign debt yields to rise in countries where banks are seen as particularly weak. Now is the time to discuss access to capital with your partners and customers, who could be negatively impacted as credit contracts this year

4. Early political turnover in debtor European countries pushes other European countries bank into crisis

Scenario: While lower sovereign borrowing costs have reduced the immediate risk of political crisis, the rapid turnover of political leadership could propel the eurozone back into crisis. For example, the turnover of Italy’s increasingly weak governing coalition would, as a result of increasing political and economic uncertainty, raise Italian bond yields but also spill into Spain, perhaps even requiring a Spanish bailout

Companies should watch for governments’ popularity, particularly in comparison to leading opposition. Unpopularity could be driven by the slow pace of reform, sustained high unemployment, and adherence to austerity policies that disrupt economic growth

5. German constitutional court rejects crisis-fighting measures

Scenario: Germany’s Constitutional Court will soon rule on the ECB’s bond-buying program, its as yet unused mechanism to protect the eurozone. The history of the court has not been to reject outright any crisis-fighting measures, though it has bestowed greater levels of scrutiny upon Germany’s legislative Bundestag. However, if it did take the nuclear option, weaker European economies would see an immediate and substantial increase in their capital costs, pushing the eurozone back into crisis

Companies should watch for the court’s decision reports. If they reject the eurozone’s anti-crisis measures outright, sovereign debt yields could increase rapidly in all European countries, particularly debtor countries, and send Europe back into a crisis of confidence

For further information on Western Europe and how FSG is tracking the region’s leading economic indicators, listen to FGS’s latest podcast, Western Europe’s Outlook Q1 2014: Download the podcast or subscribe to our Emerging Markets Podcast Series 

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