A Greek masquerade

While uncertainty caused by the Greek debacle has dented confidence in financial markets, we do not believe that a Greek exit from the euro would cause lasting economic damage to the eurozone. Notwithstanding the current situation, the eurozone economy is still expected to expand appreciably faster during 2015 than was widely predicted at the start of the year, showing better growth than in 2014.

In this context, it should be noted that Greece accounts for just 1.8% of eurozone GDP (2014), with a relatively small share of trade flows, and makes up less than 0.2% of the STOXX Europe 600 Index.

Within the political arena, it is evident that the European Commission has been using the threat of widespread economic impact as a means of stepping up the pressure on the Greek Government. For Greece itself, the near-term outlook is bleak regardless of whether it remains in the euro. In our view, its prospects would be improved by an exit, although it would still face considerable problems, not least with its institutions of government and administration. With regard to the wider European economy, Greece has been a major distraction, especially for policy makers, but momentum seems set to continue improving.

Looking to the potential ramifications for other countries within the eurozone, peripheral economies, such as Spain, Ireland and Portugal, are now showing good growth and are far less fragile than they were in the immediate aftermath of the recession. While deposit outflows from Greek banks have been substantial, this has not triggered meaningful outflows elsewhere – which would be one early sign of financial contagion. Looking at another sensitive barometer of stress, government bond yields have risen in non-Greek peripheral European markets (both in absolute terms and in relation to yields in higher-quality European markets). However, the increase has been moderate, and the Spanish government remains able to issue 10-year bonds on a similar yield to that offered by the US Treasury.

Ironically, the risk of political contagion would probably rise were significant further concessions to be made to Greece, since this would suggest to electorates in countries such as Spain and Portugal that a more belligerent approach could pay dividends.

We will continue to monitor how the drama in Europe unfolds. On a medium-term horizon, we are attracted by the valuations of European equities (outside Greece) and are maintaining our broad equity weightings; on this basis, we will look to take advantage of any unwarranted temporary weakness. It is worth noting that our diversified approach within multi-asset investment should mean that portfolios are shielded against the worst of any equity market volatility. Having said that, there are bound to be more twists and turns in the plot, and we will remain focused on the potential for unexpected consequences.

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