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Recovery continues in Europe but rate rises could still prove risky

Europe has returned from two recessions stronger and more resilient, but vulnerabilities remain as central banks begin to normalize monetary policy, economists said.

The biggest concern for the eurozone is that many countries' public finance systems remain "highly vulnerable to a sudden spike in long-term interest rates," Jean-Michel Six, S&P Global Ratings' chief European economist, said at a seminar in Washington, D.C., on Oct. 14.

The U.S. Federal Reserve has already begun normalizing its interest rates and balance sheet, while the European Central Bank has said it will begin to study tapering its bond buying program, a move that's expected to happen early next year.

Six said he expected the ECB to move from the current €60-billion-per-month bond purchasing program to about €40 billion per month, probably beginning in January, and then to stop purchasing assets at the end of 2018.

Political risk, even from events as significant as Brexit, the U.S. presidential election, and, most recently, Catalonia's independence vote, hasn't derailed economic development, Six noted.

"But populism is still present," he said, and poses some risk to an area that the International Monetary Fund expects to experience a 2.1% growth rate this year, moderating to 1.9% in 2018, according to its World Economic Outlook report released this week.

With centrist parties still in control after the France and German national elections, the spotlight shifts to Italy, which is expected to hold elections in the spring. S&P Global Ratings' Myriam Fernandez De Heredia, managing director for European Sovereigns and International Public Finance.

For the base case on the Italian elections, "we expect traditional results," De Heredia said. "There will be some rise of populist parties, but they won't be part of the governing coalition."

An improvement in corporate margins has strengthened the eurozone's growth potential, including in countries that were hit by the recession like Italy, Spain and Portugal, Six said.

"It's important to note the degree of robustness coming out of the crisis," said Rolf Strauch, chief economist at the European Stability Mechanism, an agency that assists euro-area nations experiencing financial trouble. "Spain is now growing at 3% with a current account surplus whereas before the crisis it was at 3% with a current account deficit."

Income inequality in the euro area is much lower than other parts of the world, he noted, enhancing stability and growth prospects.

S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.