Mid-year update: The outlook for Europe

11 July 2018 | Markets and Economy


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Will Brexit happen as planned? Will the euro survive? Will the European Union exist in its current form 10 years from now? In this short excerpt from a recent Vanguard webcast, Vanguard economist Peter Westaway offers his analysis.

Lara de la Iglesia (moderator): What are our expectations for Europe for the rest of 2018 and into 2019?

Peter Westaway (chief economist and head of Vanguard Investment Strategy Group, Europe): Europe's been growing pretty nicely for the last couple of years since the sovereign debt crisis was sort of put behind us. And we're now getting to the stage of the tightening cycle where interest rates will have to start rising and where many things are starting to really pick up.

I mean the interesting question politically for the European Union, especially because many of the uncertainties around whether the euro might even break up, because that's really what people were thinking about during the sovereign crisis, those are now behind us; and there's now much more thinking around how do we make the euro area countries work better together as a monetary union. So there are more proposals about having better coordination between the countries of Europe to get things working more effectively. That might even involve having a single fiscal policy, maybe even moving towards a more political union. So this is, in a way, the sorts of things you can think about when you're not in crisis mode. You can start thinking about building for the future.

Lara de la Iglesia: So the future point – I have another question here for you; and I think it's going to be, maybe perhaps, a difficult one to answer; but I know your team has been looking into it. Will the European Union have the same number of member nations ten years from now? What are your thoughts on that?

Peter Westaway: Yes, that is an interesting question. And, as you say, we're about to put out a white paper that muses on the question of where the euro's going. I think in the short run, we think the euro will stay pretty much as it is at the moment.

Looking further ahead, say five to ten years, it’s possible that more countries will join the euro, or even the EU, but I think policymakers in Europe will be a little bit hesitant because growing the EU or the euro too fast will potentially add to the stresses and strains.

And, of course, looking on the more pessimistic side, it’s still not inconceivable that some countries might choose to leave the euro; I'll stick with the euro for now. So, for example, take a country like Italy, they have just elected a populist anti-EU, anti-euro, potentially, government who could choose to drop out of the euro altogether. And that’s something that markets are starting to worry about a little bit.

So those sorts of political worries are still around. So, looking out 10–20 years, it doesn't seem unreasonable that some countries might choose to drop out altogether. But, overall, we think the euro, as a construct, is moving in the right direction and will hang together with a pretty high degree of probability.

Lara de la Iglesia: And so, what about just, very briefly, any expected impact of Brexit, which also has quite a bit of uncertainty with it right now.

Peter Westaway: Yes, exactly. I mean, people were very worried about whether the UK choosing to leave the EU might cause knock-on consequences for the rest of Europe, or even the rest of the world.

I think the impact on the UK is undoubtedly going to be quite negative because, if you choose to weaken your trading relationship with your biggest trading partner, that's almost inevitable. And I think our view would be it's going to be difficult for the UK to replace those trading ties with other ties with more distant countries.

As far as the impact on other countries is concerned in Europe, the fear that it could set in trade a domino effect, where other countries would want to leave as well, I think that really hasn't transpired the way people feared. And, if anything, the mess that the UK is still in over Brexit will, if anything, put people off even wanting to go down that road because that’s the most astonishing aspect of the Brexit issue at the moment, which is two years since the vote, we still don't know what’s going to happen.

I think the most likely outcome is that the UK will still leave the EU, probably going into some sort of customs union, which will preserve some kind of decent trading relationship. But it's possible that the UK could crash out of the EU altogether without any trade deal. And it's not completely inconceivable, though small probability, probably 10%, that Brexit still might not even happen. Because there's so much political uncertainty in the UK around getting the deal through, that it's not inconceivable that the government could fall, could go to a new government, might put the vote again to another referendum.

Not a likely event, but it’s an interesting scenario. All things are still in play.

Lara de la Iglesia: Yes. Something I know you'll be watching very closely as it plays out.

Peter Westaway: Certainly.

Important information:

This material is directed at professional investors and should not be distributed to, or relied upon by retail investors. It is directed only at persons resident in the UK.

This material was produced by The Vanguard Group, Inc. It is for educational purposes only and is not a recommendation or solicitation to buy or sell investments.

The opinions expressed in this material are those of the individual speakers and may not be representative of Vanguard Asset Management, Limited.

Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority.


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