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Inflation and energy dominate the European agenda

Inflation has proved more than transitory, with energy price rises particularly notable, while green shares could be boosted by the macro environment
December 16, 2021
  • The ECB looks set to raise rates at a later point than peers
  • Green stocks could benefit from fiscal stimulus and high carbon price

In last year’s Europe outlook, we noted the consensus view of the time that “inflation will remain subdued.” We now live in a very different world.

Investors and analysts have been peering into their crystal balls to try to decipher when central banks will raise interest rates to curb surging prices. Inflation in the eurozone rose to 4.9 per cent in November, more than double the European Central Bank’s (ECB) medium-term 2 per cent target.

Energy price rises have been an inflation driver in Europe – however you define that geographical term. The EU carbon price has almost tripled this year and electricity prices have reached over €300 (£255) per megawatt hour in several nations, up around 200 per cent since August. Continuing carbon inflation makes green energy stocks more competitive and could help utility stocks involved in carbon capture. Utility companies such as Fortum Oyj (Fi:FORTUM), the Finnish energy stock we highlighted in our last outlook, and the Norwegian renewables business Norsk Hydro (No:NHY) could benefit.

But ECB president Christine Lagarde seems to be setting a different monetary timeline for the bank from its peers. While the Federal Reserve and Bank of England are making hawkish noises on raising rates in the near future, a rise from the ECB’s negative 0.5 per cent deposit rate doesn’t look like it’s coming any time soon. Henk Potts, market strategist at Barclays Private Bank, says that an ECB rate bump “is unlikely to materialise before the end of 2023 or beginning of 2024”.

In this context, the risk that persistent inflation will hit corporate profits, denude valuations, and contribute to volatility on European bourses over 2022 isn’t unthinkable. While the ECB said in its latest bi-annual financial stability review that “inflationary pressures in the euro area are expected to decline in the course of next year,” the emergence of the Omicron coronavirus variant and its threatened impact on supply chains has already increased potential inflationary headwinds.

Fiscal policy, meanwhile, remains expansive. At the time of going to print, it is expected that the ECB will announce an end to new bond purchases under its €1.85tn euro buying scheme from March, but this is by no means certain. The massive spending programmes signed off by EU leaders in response to the pandemic look like good news for green stocks. A €750bn ‘next generation EU fund’ was approved in July which followed last year’s sign-off of the bloc’s €1.1tn long-term budget to 2027 – both are heavily green and climate-transition focused.  

European companies “for whom the green energy space is a new growth area” are well placed to gain from this stimulus says Martin Skanberg, fund manager in Schroders' European equities team. A stock like Spanish power giant Iberdrola (Sp:IBE), which recently announced a €2.3bn project to open a green hydrogen production facility, is well placed in this space. 

Political change is also in the air in Europe and this could have a significant impact on markets in the year ahead. In a union dominated by Germany, the end of the Angela Merkel era – Merkel was chancellor for 16 years – is big news. The new German government, a coalition led by chancellor Olaf Scholz of the centre-left Social Democratic Party, could herald major changes for the bloc’s direction.

Credit Suisse analysts say that the new government “may support making the EU Recovery Fund a permanent fiscal mechanism” and “there is scope for a material step forward in European integration next year”.

The reaction of EU governments to Omicron, meanwhile, provides a differentiating angle to their British and American cousins. Several EU nations have gone much further than their international peers with social and economic restrictions. Mandatory vaccinations, severe fines for non-compliance, and cutting off the unvaccinated from swathes of public life have been mooted in nations including Germany and Austria. This could hit economic confidence and consumer spending in the bloc, though it is still very early days with the new variant. 

Barclays’ Potts expects eurozone growth of over 4 per cent and analysts forecast that corporate profit growth will approach double digits for 2022. And while many European company valuations look attractive in comparison with US peers, there are warnings here too. The ECB itself has warned of overvaluation and volatility concerns in the bloc’s equity, sub-investment-grade, crypto and housing markets – “risks of price corrections over the medium term have increased substantially”, it said in its financial stability review. Investors should muse carefully on this as we move into 2022.