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Client’s view: Sylvain Broyer, Head of Economics at Natixis, on Brexit, monetary policy and market trends

Release date: 14 May 2018 | Eurex Exchange

Client’s view: Sylvain Broyer, Head of Economics at Natixis, on Brexit, monetary policy and market trends

The current economic and political situation in Europe raises a number of questions. We talked to Sylvain Broyer, Head of Economics at French investment bank Natixis, about the likelihood of another financial crisis and some key issues investors should keep an eye on.

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Dr. Sylvain Broyer, Head of Economics, Natixis

What are you most worried about – Brexit, the trade conflict between China and the US or monetary policy??

There are a number of aspects crucial to the markets, ranging from the trade war or overshooting in response to U.S. monetary policy to the yield curve inversion and possible oil price shocks due to the situation in Iran and Syria. But above all, I am convinced that Brexit will dominate the second half of the year. Why? Because the UK government and the EU are under pressure to find a solution by the end of the year. If the UK were to remain in the EU until after March 2019, they would have to hold European Parliament elections, which of course is a political no-go. They must therefore under all circumstances come to an agreement by year-end. That’s a difficult and complex task, and the further we progress into the year, the more worrisome it becomes for investors to watch. Against this backdrop, monetary policy and the trade war are minor issues. The markets do pay attention to them, but they also move on quickly.?

How tough will Brexit be, and for which side, especially??

It is too early to say how hard Brexit will hit. In the worst case, if the EU and the UK are unable to reach an agreement or have to revert to trading solely under the rules set by the World Trade Organisation, GDP might drop by 5 to 10 per cent within the next years. However, that is not where we stand currently. The UK and EU still have roughly nine months to prevent that from happening.

Moreover, the UK could cushion the negative consequences of Brexit, at least partially, via the exchange rate. Among the G7 countries, the UK is the nation with the highest account deficit in proportion to its GDP: 5 to 7 per cent. That’s even greater than that of the U.S. under Trump, which means that the UK, more than any other major industrialised economy, is dependent on foreign investment. In other words: the country simply cannot afford a “hard” Brexit. If it does occur, the UK could heavily devalue the pound to avoid or at least mitigate a major recession. We shouldn’t forget that among the G7 nations’ central banks, the Bank of England is the least independent. In an actual crisis, the statutes of the British central bank allow the government to take control of monetary policy.

Let’s return to the interest rate policy of the European Central Bank. Are we ready for a change??

It absolutely is time for the ECB to follow through on the change which has already been decided. I expect that in June or July, at the latest, the ECB will announce tapering, i.e. a step-by-step reduction of government bond purchases, from currently EUR 30 billion to zero.??

The question is whether the eurozone as an economic region would be able to cope with higher interest rates. I don’t think it could. Let’s wait and see at what point the ECB increases its key interest rate – compared to other G7 nations such as Japan, the UK and the U.S., the eurozone has not done its homework when it comes to balance-sheet restructuring. I’m talking of private rather than public debt. At 160 per cent of GDP, total private debt, i.e. the sum of debt of households and businesses within the eurozone, is currently as high as it was prior to the financial crisis. By contrast, in the U.S. and the UK, the debt ratio among private households has dropped by 20 GDP points. Should the ECB turn its back on the zero-rate policy, we will basically face a major balance-sheet problem within the eurozone. In my view, this means that the ECB will gradually phase out its quantitative easing programme, but I don’t foresee an interest rate hike this year. And then the question will be whether economic growth and inflation will stay strong enough in 2019 to justify interest rate increases.?

Rumour has it that the next financial crisis is just around the corner. What is your take on this??

The markets are nervous because the current global upswing is one of the longest we have seen in the past 20 years. You cannot, however, really compare today’s situation to that of 2007/2008, the years before the financial crisis. The global economy has merely re-balanced itself and closed output gaps, which means that there currently is no gravely overheated situation as there was in 2007, neither in the developed nor the emerging economies. Credit growth in the eurozone is restrained and a long way from an annual 5 to 10 per cent growth rate, which was the norm in the decade before the crisis. Of course, financial asset valuations are currently at extremely high levels, but that merely reflects an expansion in terms of monetary policy. We see no signs in the real economy indicating an impending major financial crisis.

What about Italy? Isn’t it a ticking time bomb??

Italy indeed is what I am most worried about next to Brexit. This concern has little to do with politics, although we have seen the country ruled by over 60 governments since 1950. In Germany, the number has been less than half that. Under Renzi, as well as during previous administrations, a number of reforms were instigated, but they are simply insufficient to really tackle the country’s problems at their core. The underlying problem is its economic performance compared to the rest of the eurozone and the G7 countries outside of Europe. The past ten years have seen an output gap between Germany, France and Italy of more than 10 per cent. Potential growth in Italy is near zero. This means that the country faces enormous difficulties in single-handedly amortising its debts.

And at what point will Greece be back on the agenda??

Right now, we are experiencing a general upturn in the European economy, which is why Greek debt currently is not a pressing issue. The same, by the way, applies to Italy. This will change as soon as the next recession or downturn is on the horizon.

Do you see signs of an imminent recession??

No. Or more precisely, not for the next few years. The global economy will develop favourably in 2018, probably better than we would have thought just six months ago, especially due to the US. We are, however, growing at a pace which the global economy, currently at equilibrium, will not be able to keep up much longer. With a bit of luck, we will see another one or two years of growth, but I expect a sharp downturn in 2020, at the latest. It could come a little earlier – we simply don’t know.?

So, if the current economic boom is continuing, what are the next major issues that investors should keep an eye on??

The upcoming EU summit in June. Emmanuel Macron and Angela Merkel have announced a solution to promote integration in Europe, which is certainly important. Whether their plans will be the quantum leap many are expecting remains to be seen.

It wouldn’t be the first master plan seeking to ensure the future of the euro; since 2013, we have seen one suggestion after another. Every member state knows what would be best in terms of a capital market union, banking union, political integration, fiscal capacity etc.; we just can’t come to an agreement. And right now, we are in a situation in which Europeans no longer necessarily want European integration. With Macron’s election, “europhoria” returned to Paris, but Paris stands relatively alone. Berlin is hesitant, and outside of Paris, the rest of France is not as devoted to the European idea as Macron would like it to be, either.

The US is on an isolationist path, as is the UK. Eastern Europe is under heavy nationalist influence, most recently proven by the re-election of Viktor Orban. Make no mistake – this isn’t nationalism born out of fear of globalisation and the consequences of de-industrialisation. Quite the contrary. Eastern Europe has never been more prosperous. It’s a gut-feeling nationalism which is of course also rooted in the fact that Europe has not been able to solve its migration issues. This has created a political environment strongly reminiscent of the early 20th century.

So what if, come June, we see no “quantum leap” in European integration??

Then we will see a development similar to that of 2012. The markets will broach the issue of dissolving the eurozone, which in turn means risk at the periphery and increased volatility. ?

In addition, investors should keep an eye on the US midterm elections. The polls indicate that Trump will retain more followers than expected. This will also have an effect on volatility, which I expect will likely continue to be a concern throughout the year and beyond.

Interview: Irmgard Thiessen?

Sylvain Broyer, Head of Economics, Natixis

Sylvain holds doctorate degrees in economics from the Universities of Frankfurt and of Lyon as well as a certification by the International Securities Market Association (ISMA).

In 2000, he joined the Portfolio Management team of the French Caisse des Dép?ts et Consignations office in Frankfurt. In 2002, Sylvain joined the economic research team of the group and has served as Head of Economics since 2008. He was appointed Member of the General Management of Natixis’s Frankfurt branch in November 2015.

He also writes columns for leading European economic magazines, teaches at Paris-Dauphine University as part of the school’s Master in banking programme, and has published numerous scientific papers as well as chapters in academic textbooks. Sylvain has been a member of the ECB Shadow Council, the Handelsblatt’s panel of leading European economists since November 2012.


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