As global temperatures rise at an accelerating rate, climate change and the policies aimed at mitigating its effects are poised to leave an indelible signature on economic outcomes. Yet, as recently observed in the eurozone, these outcomes can be shifted in a more positive direction.
Europe’s growing constituency for addressing climate change gathered pace in 2019, perhaps reflecting a ‘Greta Thunberg effect’. For example, the number of governments including the Green party now consists of Austria, Sweden, Finland, Luxembourg and – most recently – Ireland. This growing constituency has been reflected by the commitments from European governments to reduce carbon emissions and the shift in public attitudes towards climate change.
Alongside these national commitments, complementary EU-led actions have pivoted to support these aspirations. For example, the EU Emissions Trading System was established in 2005, becoming the world’s first and largest major carbon market. More recently, under the helm of Ursula von der Leyen, the European Commission announced a European Green Deal in December 2019, establishing the objective for Europe to be the first climate-neutral continent. European monetary policy has pivoted to address the climate challenge as well.
GDP uplift from recovery plan
The economic impact from the Covid-19 pandemic and the potential for long-term scarring has provided additional impetus to Europe’s climate aspirations. The recently agreed European recovery fund, known as Next Generation EU, is aimed at addressing Europe’s recovery over the next five years.
The €750bn agreement is comprised of a mix of grants and loans to European countries most affected by the Covid-19 crisis. These funds, which would be made available starting in January 2021, are targeted towards addressing climate change and digitalisation. But in order for funding to be disbursed, countries need to submit recovery and resilience plans that detail the contributions to green and digital transitions to Brussels for approval.
So how confident can we be that this initiative might be successful? There is good precedent within the European Union for strategic investment initiatives. The European Fund for Strategic Investments – often referred to as the ‘Junker Plan’ – has exceeded its investment target of €500bn, added 1.1 million jobs, and increased GDP by 1.3%, according to an EC report published in July. Assuming economic effects similar to those seen with the Juncker plan, the €750bn EU recovery plan of suggests an uplift in EU GDP of about 2% by 2024, while contributing to the economic potential of the region as well.
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The three areas of opportunity
Climate change will affect the macroeconomic outlook in Europe given the region’s commitment to addressing the challenge through the adoption of ambitious plans towards carbon neutrality. This commitment was forged by a growing constituency for addressing the climate challenge across the political spectrum and, as such, is unlikely to be unwound by a leadership change, as has occurred elsewhere. The objective of carbon neutrality is being hardwired into the very fabric of European institutions and, as such, we see this trend as having a substantive and long-lasting impact on the region.
In addition, as a large and relatively open economic region, the standards adopted in Europe to address climate change will likely have consequences far beyond the continent. Having taken a leadership role, Europe’s key trading partners will have a strong incentive to adopt similar standards in order to retain access to one of the world’s largest and wealthiest economic regions.
For the investor community, we see three areas of opportunity. First, the unity displayed by the European authorities reduces fragmentation risk and should support narrower and more stable spreads between periphery euro area country sovereign bonds and German bunds. Second, the overall size of the recently agreed upon plan and the potential boost to GDP should help sustain the recent euro appreciation. Finally, the plan is expected to support credit fundamentals, leading to tighter credit spreads. Many sectors are likely to see significant impacts, including utilities, transport and building materials/construction.