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Pressures on the EU as elections loom

John Redwood, Charles Stanley’s Chief Global Strategist, looks at the upcoming EU elections and their potential impact on markets.

EU Flags

by
John Redwood

26.02.2019

We are in the long run up to the European Parliamentary elections. This will be followed by the appointment of a new European Commission. It means there will be an argument over the future direction of EU and euro policy, with a wide range of views from those who with En Marche in France want to drive European integration further and faster, through to an array of eurosceptic and nationalist parties who want to loosen the grip of Brussels over their economies and societies. Traditionally the two pro-EU groupings of centre right and centre left have alternated in power in the EU, with the contest being between the Christian Democrat alliance and the Social Democrat alliance. These two party blocs also used to alternate in power in their domestic governments, and offered Commissioners in their own image. As a result the EU has always been governed by pro EU Commissioners and supervised by a pro EU Parliament.

Could this time be a bit different? Polls for the European elections show the EPP or centre right group on 26% and Socialists and Democrats or centre left group on 20%. In a proportional system the “winning “ group may only have one quarter of the seats. The polls show a fragmentation of both right and left, with new parties and movements in abundance. Overall, there is likely to be a continued majority for pro EU parties, but with more seats and pressure from Eurosceptic movements. In France, strongly eurosceptic National Rally alternates with pro-EU En Marche for first place in the polls. In Italy, Lega has surged to be the leading party in the polls with its mild euroscepticism overlaying its former hostility to the euro and to EU austerity policies. In Germany, Angela Merkel’s CDU/CSU coalition has a much diminished first place, at under 30%, with many more votes going to the Greens and to the anti-EU and anti-euro AfD.

Three countries this time will be offering Eurosceptic Commissioners. Poland, governed by the Law and Justice party, is seen as the new bad boy of the EU, as the government seeks to increase its control over the country and to define a distinctive approach which antagonises the core EU. Hungary under the government of Fidesz has a similar effect. Both these governing parties are likely to poll well in the European elections. Italy, with its coalition of Five Star and Lega, may also wish to submit a more contentious Commissioner name.

So, what will the arguments be about as they turn to form a new Commission after the elections? There will be disagreements about the disciplines of the Euro scheme. There is widespread dislike of the controls on the level of outstanding debt and the permitted amounts of additional borrowing. These have been integral to the Euro scheme since inception. They were put there for good reasons, to seek to stop excessive build up in debt in particular countries within the zone, and to limit free ridership of a heavily borrowed country benefitting from the better credit worthiness of other countries within the currency. These requirements led to the Greek debt crisis, which highlighted the need to have control over a state which wanted to abuse the common credit card provided by the currency and shared central bank. When the European Central Bank refused to provide all the euro Greek banks needed, the state was forced to do a deal on its borrowings.

There will be related discussions over how they could relax some of the financial stringency. Maybe they will reach agreement on increased infrastructure programmes, with new ways of permitting or accounting for the debts involved. Italy needs more money spent on bridges and highways. Germany could do with more transport spending, and has financial capacity anyway under existing deficit rules. If some elements of current infrastructure programmes were treated differently in the accounts, more could be spent on benefits and boosting incomes, as many on the left would like to do in France, Italy and elsewhere. The EU has always been fairly tolerant of the many countries that infringe the rule to keep their state borrowing down to 60% of GDP, but much less tolerant of exceeding the annual deficit limit of 3%.

There will also be tensions over how far the EU should go in establishing more controls over member states. Should there be more common taxation, so there can be a higher EU budget? Can you have a successful single currency without the common Finance Minister and budget that France and some in the current Commission argue for? So far, the EU has muddled through without proper transfers of money from rich to poor by the surplus countries lending money to the deficit countries at zero interest through the ECB. Are they ready yet to have an honest conversation about an alternative to this mechanism which recognises the need to send grants to parts of the zone that are struggling?

There is likely to be some turbulence during the election period as polls fluctuate and as arguments are intensified over the future of the currency and the EU government. This is a negative for Eurozone assets. Thereafter, it is possible the new EU takes some steps towards a fiscal relaxation, finding a way to spend a bit more without taxing more. That would be mildly helpful. If they took it too far it would be alarming, as the wrong kind of relaxation intensifies the debt problems of the deficit countries in the currency.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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