Important Links

Rising Political Risks in Europe

23 October 2017PoliticsEquitiesEurope

The rise of the right-wing Alternative for Germany (AfD) party in the German Federal elections, the unrest following the Catalan referendum and the inertia in the UK's Brexit negotiations suggest that political risks may be rising in Europe.

In October's Austrian elections, the far right Freedom party won 26.9% of the votes, its strongest results in two decades. There is a possibility that the party could join the next government as a junior coalition partner.

The Italian general election in Spring 2018 is likely to become the next major European political event to attract investors' attention.

What to expect from the Italian elections?

Italy's anti-EU/anti-euro sentiment is among the strongest in the EU and unlike other countries within the region, it is not reducing. See Chart 3.

However, Citi analysts note that populist parties in Italy have softened their most extreme positions demanding an EU referendum, aware that deals with mainstream parties are inevitable if they want to get into power.

Citi retains the base case scenario of Italian party Five Star Movement (M5S) coming first in the election and attempting to form a government with parties (or portions of parties) from the left of the political spectrum.

Citi does not expect a single party/coalition to win an absolute majority in the election. Coalition building will likely be complex and potentially involve further parties splintering. However, the likelihood of another election in 2018 is low.

The next Italian government is unlikely to make much progress on the reform agenda and on fiscal consolidation, but the ongoing cyclical recovery may help Italy to continue economically struggling through. In Citi's view, it will likely take the next economic recession for Italy to seriously return to its reform agenda.

Moody's negative outlook on Italy (Baa2 negative) reflects the diminished likelihood that the Italian government will make meaningful additional progress on structural economic and fiscal reforms. But with growth surprising to the upside, Citi analysts expect no change in the rating for now.

How will Italy's political uncertainty affect the euro?

Despite the cyclical recovery in Italy, several key economic indicators are still lagging below 2008 levels.

Public debt remains stubbornly high (See Chart 4), which could put the long-term sustainability of Italy and possibly the euro at risk. However, Italy's cyclical recovery may prevent the fiscal deficit from widening dramatically from the current 2% of GDP. Slightly higher nominal GDP growth can also help to stabilize the public debt ratio.

For now, Citi continues to project medium term upside for the euro, supported by attractive valuations, a large current account surplus and a cyclical recovery within the eurozone. With the European Central Bank expected to taper its bond purchases and the Federal Reserve unwinding its balance sheet, the potential narrowing of the spread

Between European and US bond yields may slow bond portfolio outflows from the Eurozone, thereby supporting the euro.

Still positive European equities

Citi analysts remain positive on European equities. The cyclical recovery in the Eurozone is broadening across sectors and countries. Citi has recently raised its above-consensus GDP growth forecasts for the Eurozone to 2.3% in 2017 and 2.1% in 2018, due to faster growth estimates for both France and Italy.

The DJ Stoxx 600 is still attractively priced on a relative basis at 15x 2018 forward price to earnings ratio and corporate earnings are expected to grow 8.8% in 2018.

Europe's dividend yield of 3.2% is also attractive and expected to remain the highest among the regional equity markets in 2018. High dividends can provide a buffer against equity market volatility in the months ahead.

Keeping watch

The common thread running through the political uncertainty in Europe appears to be a chronic leadership vacuum. The political elite across Europe is perceived to be either out of touch with the electorate or unable and/or unwilling to champion and drive through reform. Moreover, there is a growing divide between the reform that is being demanded by the electorate and what is needed for sustainable future growth.

In recent years, financial markets have continued to rise looking beyond significant political changes. Citi analysts believe this is because the connection between political events to their real impact on the economy are often unclear and have been cushioned by large quantitative easing programs.

In the current round of political events, potentially negative economic impacts are becoming easier to envisage. Opposition to reforms in Germany, headwinds to the Franco-German alliance and a possible fragmentation of Italy – Europe's fourth largest economy – are meaningful risks against the backdrop of the Euro, which has strengthened sharply this year. Threats to fiscal control and to financial conditions are also potential risks for bond investors. And the possibility of the UK breaking its ties with the Euroland, which makes up over half of its trade is already having ramifications on the Pounds (GBP), UK inflation and the UK domestic economy.

While Citi analysts continue to expect positive returns from European equities over the next six to nine months, Citi remains watchful on the longer term outlook for the Eurozone.

Key Takeaways

  • The unexpected outcome from the German and Austrian elections, the unrest following the Catalan referendum and the inertia in the UK's Brexit are indicators that political risks may be rising in Europe.
  • The next Italian government is unlikely to make much progress on the reform agenda and on fiscal consolidation, but its ongoing economic cyclical recovery may help Italy to continue struggling through.
  • While Citi analysts continue to expect positive returns from European equities over the next six to nine months, Citi remains watchful on the longer term outlook for the eurozone.

Our recent research

A Redefinition of Value Investing

Diversification into cyclical markets, particularly value stocks with still subdued valuations, remains preferred. Citi analysts consider four strategies to identify where "value" may be for certain companies.

Find out more


Assessing the Pullback in the Technology Sector

The technology sector is seeing some pressure after a rally that has surpassed expectations. COVID-19 cyclicals were more resilient, consistent with Citi analysts’ preference of rotating from growth to value stocks amid a cyclical recovery. Looking ahead, Citi analysts believe this is more likely a correction rather than the start of a broader downturn, as the cyclical recovery remains intact. Nevertheless, further volatility is expected due to the upcoming US Presidential election and ongoing pandemic. With US equity valuations at a historic high relative to others, investors could also look to diversify into non-US markets.

Find out more


Going Cyclical in Asia

Investors in Asia have flocked to COVID-19 defensive or growth sectors like technology this year, while COVID-19 cyclical or value sectors have lagged significantly. Citi analysts expect this relative performance to reverse, at least partially, as re-opening takes place.

Find out more

EquitiesAsia PacEmerging Markets

Take the first steps to your wealth management planning with Citi

Speak to a Relationship Manager
0207 500 1992

Already with Citi? Contact your relationship manager or view product availability on Citi Online

Why choose Citi

A relationship - not just a bank account

A dedicated Relationship Manager giving you access to our internal team of product experts and all our benefits

Access to exclusive Citi products

A range of current and investment products available both on shore and offshore, in the currency of your choice
Multi-currency accounts
Investment products

Global services for a global lifestyle

Our team is here to support you getting started in UK or with International travel and relocation
Moving to and from the UK
Travelling overseas

Offshore investments

We offer a diverse range of banking and investment services, including for those who want access to offshore investments

Find out more

Just moved to the UK?

We can save you time money and hassle. If you are a foreign national in the UK, Citi's International Banking Service can help you manage your money, home and away.

Find out more

Investment products are not insured by any governmental agencies, are not bank deposits, and are neither obligations of, nor guaranteed by, Citigroup, or any of its affiliates, unless otherwise stated. Investment products are subject to investment risks, including possible loss of some or all of the principal amount invested. Past performance is not indicative of future results, investments can go down as well as up.

“Citi analysts” refers to investment professionals within Citi Research (“CR”), Citi Global Markets Inc. (“CGMI”) and voting members of the Citi Global Investment Committee. Citibank N.A. and its affiliates / subsidiaries provide no independent research or analysis in the substance or preparation of this document. The information on this page has been obtained from reports issued by CGMI. Such information is based on sources CGMI believes to be reliable. CGMI, however, does not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute CGMI’s judgment as of the date of this page and are subject to change without notice. This page is for general information purposes only and is not intended as a recommendation or an offer or solicitation for the purchase or sale of any security or currency. No part of this page may be reproduced in any manner without the written consent of Citibank N.A. Information on this page has been prepared without taking account of the objectives, financial situation, or needs of any particular investor. Any person considering an investment should consider the appropriateness of the investment having regard to their objectives, financial situation, or needs, and should seek independent advice on the suitability or otherwise of a particular investment. Citi Research (CR) is a division of Citigroup Global Markets Inc. (the "Firm"), which does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this information. Investors should consider this information as only a single factor in making their investment decision.

Opinions expressed herein may differ from the opinions expressed by other businesses or affiliates of Citigroup, Inc., and are not intended to be a forecast of future events, a guarantee of future results or investment advice, and are subject to change based on market and other conditions.