Recent geo-political developments may have economic benefits in the sort-term but in the longer term...

Many commentators have hasted in concluding that the recent geo-political developments will have, after all, economic benefits. This may be the case in the short-term but the real negative effects of heightened uncertainty can come later. We should be cautious in drawing hasty, positive conclusions from those market developments because they may not necessarily indicate that the world economy will have an accelerating recovery with higher growth. So far, those developments point to a U.S. rise in economic growth, but in the context of an "America first" policy. Three factors may contribute to mitigate or even reverse its international spillovers.

The first is the possibility of rising protectionism - hard or soft - that can substantially reduce the effect of higher growth into higher U.S. imports. World trade, already quite weak, may continue to collapse, hurting all open economies dependent on exports.

The second are the negative effects that we are already witnessing in emerging market economies (EMEs). In fact, significant capital outflows and exchange rate depreciations already underway can hinder future growth. Protectionist measures directed particularly against large emerging economies may further decelerate world economic growth and create instability in foreign exchange markets.

The third factor concerns Europe. In this first wave, Europe apparently benefited from positive contagion with some increase in equity prices and a steepening of the yield curve, favouring financial institutions. As concerns equities, the low starting point seems favourable for European markets. Share price levels are relatively subdued in Europe with, for instance, a Cyclically Adjusted Price Earnings (CAPE) Shiller index of just 14 against 27 in the U.S. This means that European shares, including those of banks, are undervalued with respect to other parts of the world and could thus attract investors. However, we already observed a slight drop in European share prices last Friday. According to market analysts, this was explained by fears concerning protectionism and EMEs' growth prospects as well as the possible resulting decline in global trade.

Besides these external concerns, Europe's internal problems may deter it from fully reaping the benefits from the expected expansion in the U.S. Indeed, a range of political risks may induce economic shocks. To face heightened world uncertainty, Europe would need to deepen its unity and integration, relying more on its domestic market to underpin higher growth. In turn, this implies that Europe needs more expansionary macroeconomic policies and more reforms in the regulatory and competition policy fields, in order to improve the economy's supply side. Without higher real and nominal economic growth, Europe will have greater difficulty in overcoming its challenges.

Speech by Mr Vítor Constâncio, Vice-President of the European Central Bank, at the 19th Euro Finance Week: Opening conference, Frankfurt am Main, 14 November 2016.