Europe still capable of spoiling UK’s “good mood”

The sense of self confidence in the UK left by the Olympics received another boost this week as the retail sector surprised a few by recording a small upturn in July.

Unfortunately, Europe continues to cast a shadow over our optimistic mood here in the UK. European politicians should start trickling back from their summer holidays soon, with Angela Merkel returning from a walking holiday in Italy on Wednesday (ironically Italy may well be asking for stimulus after the Italian 50km walking champion was disqualified for doping in London). Until they are all back, there is little that can be done to resolve on-going European issues.
The pressure will be increasing on Frau Merkel’s shoulders in the coming months as the contagion once again creeps across Europe towards the core. Nine months ago we were looking at a European split between a core that was exhibiting few economic signs of being shackled to a dead albatross like Greece and a periphery with borrowing costs spiralling rapidly out of control.
German bond yields have started to tick higher over the past month, demonstrating that the market is increasingly worried about the German financial situation. In the past, traders were buying German debt as a hedge against the European issues on the basis that, if there was some form of break-up, Germany would be in the strongest position. This has reversed in recent weeks as the market mind-set has now switched to the expectation that any bailout package for the periphery will add to the overall German debt levels.
While the Greek and Spanish elections have had their own individual market impact, the German election – due next autumn – will be far more important. Merkel was castigated for referring to the Greek election as a “referendum on the euro”, but she was right. While not every election will carry the market weight (most have forgotten about the rise of François Hollande) that Germany’s does, the principles voted on by the German electorate will become policy for those of the rest of Europe.

The autumn months could be crucial for the entire region, of which the UK is a big part.

Jeremy Cook is chief economist at World First foreign exchange