A threat for Europe’s economy is not yet one of rising inflation – as can be the case when an economy shows signs of improvement – but that price pressures are “dangerously low”, reckons Lorne Baring, managing director of B Capital.

A threat for Europe’s economy is not yet one of rising inflation – as can be the case when an economy shows signs of improvement – but that price pressures are “dangerously low”, reckons Lorne Baring, managing director of B Capital, a London/Geneva-based investment house.

“Europe has finally crawled out of recession and is still improving but this is coming from a very low base. It looks certain that in 2014 the European region will need more help from the [European Central Bank] to try to ease the tight credit conditions blighting the economy as well as to push up inflation,” he said in an emailed investment commentary.

“The latter seems an odd thing to be concerned about as historically fears have often been centred on keeping control of inflation as economies expand yet today the threat to Europe may indeed be that inflation is dangerously low,” he said.

“It is likely that whilst some central bankers begin to think of more tightening, the ECB will be moving to loosen monetary policy even further,” he said.

Turning Eastward, Baring said that with debate on whether or how China’s economy will decelerate, the risks appear more worrying than may be warranted.

He argued that regional imbalances will, in some ways, increase, with some countries being required to tighten monetary policy, while other jurisdictions have to become more hawkish.

“Turbulence will reoccur in the months ahead as investors try to gauge the speed of the US recovery versus the slowdown in China, and also to what extent Europe needs further ECB support. The fastest and potentially largest moves will be in the currencies and the war between trading blocks to lower their own currencies to promote export expansion will be interesting to watch as the year progresses. Not everyone can win the currency race to the bottom,” Baring said.

Base case
“Our base case for the world economy is now several years of low growth and also subdued inflation, which will allow short term interest rates to remain very low. Out of the four main economic regions we see the US accelerating slightly upwards from the middle of the pack, China slowing from the top of the group and finally Europe and Japan in the lower growth band but possibly improving,” he said.

A risk is that eurozone inflation falls further (currently around 0.8 per cent), which causes a slide back into recession, while another risk is a faster-than-expected deceleration in China.

“The scenario for markets is likely a moderately bullish case for equities and a more stable but still flat outlook for bonds. Within the asset classes, in developed market equities we suggest that the sweet spot will be international equities that provide a dividend income superior to bond yields,” he said, adding: “We are tilted towards European equities on price valuation and a view that the ECB will support the economy actively through the year. Emerging market equities in general are vulnerable however our valuation models lead us to the Middle East region – some may call this a `frontier’ market – where GDP growth is strong, inflation is benign and the population is benefitting from comparative youth and also investment in infrastructure, education and health due in some part to Arab Spring which has catalysed change in the region.”

Launched in 2008, B Capital runs $500 million on behalf of 20 clients.