The presence of parties and movements advocating abandonment of the monetary union, and which enjoy significant popular support, is undoubtedly a factor. However, break-up risk is not that likely to materialise this year. The costs of recent political trends are less extreme and more long-term…..
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Intesa Sanpaolo – Research Department For professional investors and advisers only
With our analysis of the Dutch political elections scheduled on 15 March, due for publication this week, we being our coverage of the European electoral cycle in 2017-18. In a month’s time, we will focus on the presidential elections in France, where the official list of candidates has now been defined, and the electoral campaign is coming into full swing.
The forthcoming round of elections will be unusually dramatic, given the robust presence of anti-euro and anti-EU movements. In Holland, France and Italy, euro-sceptic movements are competing for first place in voting intention polls, and have made a return to currency sovereignty a central point of their nationalist manifestos. Therefore, it is no surprise that, as the elections near, spreads between sovereign yields are showing signs of tension, and downside pressures on German debt yields are resurging. While the redenomination risk tied to doubts on the refinancing of debt could be opposed by the reaction of the authorities, as was the case in 2011-12 with the creation of the EFSF and the ESM, and the launching of OMTs by the ECB, there is nothing the central bank or the Council could do if a country decided, resorting to its own democratic procedures, to abandon the monetary union: the promise of doing “whatever it takes” made by the ECB President in 2012 would only help contain the domino effect.
The Netherlands’ case, however, shows that the taxonomy of risks may be more complex and markedly less dramatic than a straightforward in/out choice. In Holland, as we explain in the following section, the proportional electoral law will yield a parliament in which the party opposed to the euro may a relative majority, but remains isolated and distant from achieving an absolute majority of seats. In France as well, voting intention polls point to a clear defeat of Front National at the second round. The tail-risk that one of the major countries of the euro area may opt to abandon it will not materialise in the near term. Therefore, the precautionary portfolio shifts that have been involving European government bonds in the past few weeks may ultimately represent a buying opportunity. The most tangible problem posed in the immediate term by the advancement of the populists, on the other hand, is the fact that it creates further obstacles to the attempt to improve the institutions governing the euro area and the European Union, something which goes well beyond the normal attention span of markets. It is ultimately easier to argue that the EU is preventing what needs to be done from happening, rather than to propose solutions: Rutte, in Holland, has already given in to the temptation to “steal” some manifesto points from the populists, instead of tackling the issues which have led to their rise. While these may only be pre-electoral tactics, the risk is that a subsequent failure to live up to campaign promises could further strengthen the populist forces at the next elections. Unfortunately, this outcome may also be encouraged by a decision to form a diverse coalition in order to keep the xenophobic party out of office.
In total contrast with these trends, in Germany the SPD has found renewed vigour with the decision of the former President of the European Parliament to run for office, whereas the Chancellor, despite the approaching elections, has spoken out in favour of relaunching the socalled “enhanced-cooperation” mechanism already provided for by the Treaties. However, this is a methodological proposal, not a plan: the cost/benefit balance will depend on the contents, and this is where hitches could emerge. It should be noted that enhanced cooperation does not apply to matters that are the exclusive competence of the Union (which include the euro, the single market, and trade policies), but could involve defence, the judicial system, and foreign policy, and has already been used to propose the European tax on financial transactions.
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