This year is seemingly an exciting year for the European market. While the Brexit deal has drawn a lot of attention, folks forget how Germany’s current economic and political situation might rattle the market.
The EU’s largest economy again hit a record high to be the world’s largest current account surplus country in 2017. In the first 11 months of 2017, the trade surplus in goods was €249 billion even when imports grew by 8.3%, higher than exports.
The announcement is likely to bring up criticism of the economic and fiscal policies in Germany. President Trump accused the country of “very bad” trade policies while the European Commission and the International Monetary Fund (IMF) have urged German authorities to lift domestic demand, imports and the government spending to reduce global economic imbalances.
It is not the gap between imports and exports that causes the trade surplus. Factors like high savings due to aging population, low government investment and a low wage rate are the main reasons for this issue. With the recent speech, the president of the German central bank stated “Raising public spending in order to reduce Germany’s current account surplus would likely be a futile undertaking”, as the country expects upcoming demographic pressures.
The large continuing trade balance of Germany means large trade deficit for her trading partners. As 8 out of the 10 largest exporting countries of Germany are from the Eurozone, the trade surplus is more problematic for the European economy. Being in the European Union not only creates favourable trade deals for Germany but also makes German goods artificially cheap with the euro. If Germany still kept Deutschmark, her real exchange rate would rise by approximately 20% compared with the euro. While other countries under the same roof, such as Greece, are struggling to maintain the expensive euro in their system, Germany is seemingly the only one to enjoy the current rate of the shared currency. The stronger Germany’s economy, the more burden Europe’s least-developed nations share.
Different from her economic achievement, Germany still remains without a formal government after a general election last September. It is relatively concerning not only for Germany but also the Eurozone as the coalition talk might hold back the EU reform plans.
In spite of the political impasse, the European market performance still remains optimistic. Since last September, the euro has been volatile with an upward trend setting a record of a three-year high. On the other hand, the DAX index soared after hitting the lowest level in early last September. The U.K.’s FTSE 100 Index also soared to another record closing high in the past 3 months. The strongest performer is the pan-European Stoxx 600 as it closed 0.54% higher after hitting its highest level since August 2015.
Figure 1: EUR/AUD exchange rate
Figure 2: DAX Index
In early January, Germany moved a step closer to form a government after months of political uncertainty with the agreement of the centre-left Social Democratic Party (SPD) to begin formal coalition talks with Chancellor Angela Merkel’s conservatives. The news sent the euro surging above $1.21 against the greenback for the first time since 2015.
Overall, while the strong economic performance of Germany causes the European economic imbalances, the political uncertainty has not negatively affected the German and the European equities market. Even though the country is satisfied with its achievements, the low public and private investment and government spending records would not help Germany remain attractive to investors in the long-term, which is not a good case when the aging population issue kicks in. In order to maintain the leading position, Germany should come up with practices pursing the economic balance with the Eurozone.
This content has been written and published by KOSEC – Kodari Securities.
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