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With the fog of political uncertainty now having largely lifted from many – though admittedly not all – European economies, it’s time to focus on the fundamentals again. Andy Cates, Chef Eurozone Economist, explains why one of the most important and under-appreciated reasons for our optimism is the improving labour markets in many European countries.

European labour markets are improving

Labour market activity has been improving in recent months and forward-looking indicators suggest further broad-based improvements are on the horizon. Youth unemployment has fallen very sharply in a number of peripheral economies, most notably in Italy. This is positive news for wage inflation and consumer spending growth.

Falling youth unemployment tends to be a big positive for consumer spending trends as it typically generates firmer household income growth and unleashes strong pent-up demand at the same time.

Unemployment and political stability

The fading support of populist parties across Europe can, in part, be traced to their improving labour markets. Our work has shown a fairly tight empirical relationship between Populist Party support levels and factors such as unemployment, equity market gyrations and refugee-related news flow. In the period ahead, we believe unemployment in the eurozone will continue to fall and equity prices to rise. We also expect no further escalation in Europe’s refugee crisis which should translate into a further decline in the support for populist parties.

Declining support for populist parties


What does this mean for investors?

The relationship between unemployment rate and ECB deposit rate   

With politics taking a back seat, youth unemployment rates moderating and fundamentals coming back into focus again, we expect GDP growth and inflation to surprise consensus forecasts on the upside in the coming months. This leads us to believe that an ECB policy normalisation may be closer than the market is expecting and we believe the ECB will announce a QE tapering plan in October 2017 and the first hike in the deposit facility rate to occur in the fourth quarter of 2018.

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