The elections this month that will determine the composition of the future European Parliament have been described as the most important ever. As the elections influence the economy and the financial markets, they are of great importance also in these areas but not for the reasons commonly thought of.
From the markets' point of view the main focus will be on the outcomes in Italy, France and the UK and what a potentially new political landscape may carry with it.
• In Italy, a strong result for Lega Nord could lead to early elections, deepened political uncertainty and further market worries
• In France, the election results will matter greatly for Macron’s reform agenda
• In the UK, the outcome could again increase the odds of a no deal Brexit
Decision-making in the new European Parliament will become more difficult, but it should have only limited near-term consequences for the economic and market outlooks, respectively.
Elections to the European parliament will take place between 23 and 26 May. A total of 751 Members of the European Parliament will be elected, but the number will fall to 705, if the UK eventually leaves the EU.
The new parliament is set to become even more fragmented, which will make decision-making more difficult (see more below). However, it is unlikely that the new composition of the parliament will have a material impact on the shorter-term economic and market outlooks, even if it will have longer-term implications.
Nevertheless, the vote matters a great deal for the shorter-term outlook as well, but mainly because of the issues on ballot in a number of member states.
A triumph for Lega Nord could lead to early elections in Italy
Disagreements between the ruling Italian parties, ie the Five-Star Movement (M5S) led by Luigi Di Maio and Lega Nord led by Matteo Salvini, have increased lately. Boosted by poll results, Salvini has started to behave even more as if he were the Italian Prime Minister, despite being the leader of the clearly smaller government party. M5S, which some years back was seen as the greatest threat to the Euro area, has in turn moderated its stance in the government – and seen they party’s support wane in the polls.
If the Lega does well in the EU vote, Salvini may not be able to resist the appeal of breaking up the current government and trying to push Italy to early elections. He could then aim for the post as Prime Minister in collaboration with more traditional allies, including Silvio Berlusconi’s Forza Italia.
Irrespective of the eventual outcome, the prospect of a Prime Minister Salvini, with his known EU scepticism and open defiance of the EU rules, would scare financial markets. This would most likely lead to renewed volatility in the Italian government-bond markets, and probably hurt economic confidence on the Euro-area level as well.
Macron’s reforms at stake in France
In France, President Macron’s reform agenda has been paralyzed by the yellow-vest protests. The protests have lately calmed down after concessions by the President and Macron’s popularity has rebounded from the lows seen late last year. It would thus be premature to throw in the towel regarding Macron’s reform programme.
Reform of the European Union is close to Macron’s heart, which is why the EU elections are very important for him. The outcome will also be important for the outlook of his domestic reform programme. Macron’s La République En Marche! (LREM) is polling close to Marine Le Pen’s Rassemblement National (RN), and a victory for Macron would give his agenda a boost. Conversely, if RN is the biggest party in the French vote, it will be more difficult for Macron to carry out his agenda.
Macron’s reforms have brought hope to the Euro area as a whole, showing that there is an alternative to the rising wave of populism that offers simple but flawed solutions. In other words, Macron’s reforms matter not only in terms of the French outlook but would impact the Euro area as a whole.
Without continued structural reforms, the focus could shift back to the sizable French public deficits, which are already seeing upward pressure due to Macron’s concessions to the yellow-vests.
No deal Brexit back on the table
It has become increasingly clear that Prime Minister May won't be able to gain a parliamentary majority for her agreement, while she probably doesn't have many months or even days left as Prime Minister. However, the results of the EU elections are increasingly seen as another referendum on Brexit, and the outcome will matter for the selection of and stance taken by May’s successor.
Nigel Farage has formed a new political party, the Brexit Party, which supports the UK leaving the EU without a formal withdrawal agreement. At the same time, the Liberal Democrats, along with smaller parties like the Change UK, are supporters of the UK remaining in the EU. May’s Conservative party, in turn, may end up being only fifth largest party in the vote.
A strong result for the Brexit Party would be interpreted as voter support for a harder form of Brexit. It would also likely intensify market worries that such an outcome would be back on the table again and further cloud the outlook for the GBP. However, rather than on the support for individual parties, focus will be on the total support for parties backing a particular Brexit-related outcome.
Rise of extreme parties worrying, but…
It looks clear that the new parliament will become more fragmented compared to the current one. Currently, the two biggest parliamentary groups, the centre-right European People’s Party (EPP) and the Progressive Alliance of Socialists and Democrats (S&D), constitute a majority in the current parliament. It looks very likely that at least three parties will be needed for a majority after the elections.
Generally, the biggest focus seems to be on the rise in polls of the various extreme parties. This is a phenomenon that has been evident also in many national elections but is amplified in the European elections, where it appears easier for people to vote against their government and cast a protest vote. In other words, it is not always the matters that the European Parliament actually has authority over that determines who people vote for.
Polls suggest such extreme parties could win as much as a third of the seats in the new parliament. There is no doubt that finding majorities will be more difficult in the new parliament and decision-making may become even more cumbersome. However, the extreme parties are a very divergent group. They haven't been able to unite under a single umbrella, which limits their post-election influence.
Further, the broad political direction and priorities of the European Union and the Euro area are defined elsewhere: such as in the European Council, consisting of the heads of state of the EU member states. Another important power factor is the President of the European Commission.
The discussion regarding the division of top EU jobs will probably pick up steam after the elections. From a market perspective the most important question will be the name of Mario Draghi’s successor as head of the European Central Bank. The new President of the ECB will start in November.
As a result, the future composition of the parliament is is seen affecting the medium-term outlook on the economy and the financial markets more than what is expected in the near term.
/Jan von Gerich, chief analyst
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