The EU heads of state have come up with their list of nominees to head the European institutions. The chair of the IMF, Christine Lagarde, has emerged as the (dovish) compromise candidate for the European Central Bank (ECB). If confirmed, she would be the first ECB president without any experience in monetary policy. We think her management experience, including her tenure as IMF chair, would help her to lead the ECB. But she will likely face many challenges:
- The ECB is aiming to counteract a prolonged period of economic weakness with relatively limited firepower. Its key policy rate is already -0.4%, so it has less leeway than the Federal Reserve does to act.
- The Eurozone economy is highly sensitive to global demand, which has been undermined by concerns about global trade. The recent truce between the US and China may improve the situation, but at present the new orders component of the composite global purchasing managers' index is at just 52 – barely above the 50 level that separates business expansion from contraction – and has been trending lower. The ECB has also downgraded its Eurozone economic growth forecasts. It sees the rate of expansion as significantly lower than in the US.
- In the Eurozone, core inflation excluding food and energy rose just 1.1% in June.
The nominations are still tentative, and there is a high risk that the European Parliament rejects them. But whatever the outcome, we still expect the ECB to remove the tightening bias from its interest rate forward guidance on 25 July, and we see no rate hike next year.
And while the IMF chief is considered a qualified candidate, that won't necessarily make Europe a more attractive place to invest over our tactical horizon. Eurozone stocks aren't cheap at 13.6x their 12-month forward P/E versus our fair value estimate of 12x. Within international developed market stocks, we recommend an underweight to Eurozone equities, whose gains have outpaced economic fundamentals, in our view.
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