Europe’s non-financial corporate sector will enter 2018 with “favourable tailwinds” according to a new report from ratings agency S&P titled “European Corporate Credit Outlook 2018: On the Up”.
The report points to economic recovery in the eurozone and a synchronised global upturn as reasons for believing that corporate default rates will continue to hover around 2 percent next year – compared with an average default rate of 3.3 percent since 1999.
S&P says the financial cycle has run far ahead of the economic cycle, inflated by extremely low interest rates and quantitative easing. Many risk assets are priced for perfection with absolute yields low, credit spreads tight, volatility absent and equity valuations stretched after the second-longest bull market in history.
In a normal cycle, S&P says, the gap between the economic and financial cycles would close with financial markets correcting as interest rates go higher. But this is “far from a normal cycle” – despite the global upturn, inflation pressures are low, unemployment rates are high and labour cost pressures negligible.
Economic slack means that the European Central Bank is likely to leave interest rates unchanged until at least 2020, according to S&P, and will sustain quantitative easing until at least September of next year. The Bank of England is also likely to hold off from further interest rate rises with the UK economy slowing and facing considerable uncertainty in the run up to Brexit in March 2019.
Taking this into account S&P says the outlook for corporate credit is positive despite a range of risk factors including politics, US trade and tax policy, quietly resurgent commodity prices and the build-up of Chinese non-financial debt. S&P thinks positive economic growth and supportive monetary policy will continue to win out over the downside risks.
S&P also predicts an increase in M&A activity in 2018, with “substantial” growth on recent lacklustre volumes as pressure grows on competitive positions and business models. “Depending on financing terms and the level of operational risk in deals, this may prove one of the greater risks to credit ratings in the year ahead,” the report notes.