European Elections Guide 2016/17

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Europe on edge ahead of crucial election period

Following the Brexit vote in June and Donald Trump’s shock US election victory, financial markets are growingly concerned about a rise in support for anti-establishment movements across Europe.

We had the Italian constitutional referendum in the first week of December. The referendum, aimed at slimming down the country’s legislature and speeding up lawmaking, yielded a resounding “No” vote, with around 60% of voters rejecting the proposals.

Renzi’s defeat is likely to set a negative tone ahead of a crucial few months of high profile elections in Europe. France will go to the polls for its Presidential election in May. Germany will also hold a federal election in the third quarter of 2017, while the Netherlands has its own general election in March.

The unreliability of the opinion polls for both the UK’s EU referendum and the US Presidential election has made investors increasingly nervous about the risk of contagion in Europe. The combination of this and expectations for higher growth and interest rates in the US following the Trump election victory, has already seen the Euro fall sharply to its weakest position in over a year-and-a-half (Figure 1). We think there is room for further depreciation in the single currency, particularly against the US Dollar.

Figure 1: EUR/USD (December ‘15 - December ‘16)

Source: Thomson Reuters Datastream Date: 05/12/2016


Netherlands

An election that could prove a major event risk in Europe next year is that in the Netherlands in March. Geert Wilders, the leader of anti-EU, anti-immigration Party for Freedom is comfortably ahead in the polls and looks likely to receive the most votes in next year’s general election.

However, support for Wilders is currently nowhere near enough to form a majority - he is predicted to win around 30 of the 150 seats on offer, although this would be a significant increase on the 15 the party currently holds. With many of the mainstream parties looking certain to dismiss him as a coalition partner, we could see a scenario where an unprecedented four or five centre-right and centre-left parties come together to form a coalition government.

The main risk is a stronger-than-predicted showing by Wilders’ party that would make it very difficult to form a coalition that excludes him.


France

The possibility of a Presidential election victory for Marine Le Pen in France has gone from unthinkable to plausible. Le Pen, leader of the far-right National Front, looks increasingly likely to make it through as one of the top two candidates in the first round of France’s Presidential election in April. This would likely directly pit her against former French Prime Minister and now surprise clear favourite François Fillon in a second round vote to decide the next President in May. Fillon, who ended Nicolas Sarkozy’s hopes of becoming the next President in the party’s primary vote in November, is expected to garner the majority of sympathiser votes once the first round of elections are complete. The PredictIt website are currently giving Fillon around a 60% chance of winning compared to 35% for Le Pen (Figure 2).

Figure 2: PredictIt France Presidential Election (September ‘16 - December ‘16)

Source: PredictIt.org Date: 05/12/2016

A victory for the anti-immigration, anti-free trade National Front Party would almost certainly lead to a referendum on France’s future within the European Union. While opinion polls show France remains firmly in favour of remaining in the EU, the surprise Brexit vote in June means that this risk cannot be discounted. A French exit from the European Union, or “Frexit”, would call into serious question the long term future and sustainability of the European bloc.

However, it is worth noting that polls give Fillon a 70-30 advantage in second round voting. While polls are less reliable than they once were, this is a very steep hill for Le Pen to climb.


Germany

German Chancellor and leader of the Christian Democratic Union Angela Merkel has announced she will be running for her fourth term in office next year. This could see her extend her run as Chancellor to 16 years since coming to power in November 2005. However, Merkel’s approval rating has fallen over the past twelve months to around 55% from more than 70%, with her CDU Party now polling at around 30% compared to the 41.5% of the vote obtained in the 2013 Federal election. Her decision to let almost one million asylum seekers into Germany last year allowed the populist and anti-immigration Alternative for Germany (AfG) Party to record wins in recent state elections.

While Frauke Petry’s Alternative for Germany (AfG) Party has received an increase in support of late, it still sits at a modest 10-15%. At present, it looks unlikely to mount a realistic challenge when Germans go the polls in the third quarter of next year. PredictIt has shown Merkel opening up a comfortably advantage over her rivals in the in the past few weeks (Figure 3).

Figure 3: PredictIt German Federal Election (September ‘16 - December ‘16)

Source: PredictIt.org Date: 05/12/2016


Italy

While the ‘No’ result at December’s referendum had been largely expected by the market, the magnitude of the defeat for the Italian establishment was bigger than even the most pessimistic polls had predicted. Just shy of 60% of Italians voted against Renzi’s proposed changes to overhaul the country’s legislature.

The crushing defeat prompted Prime Minister Renzi's resignation and leads to a period of political uncertainty, bringing forth the prospect of new elections in Italy, originally set to take in 2018. This could pave the way for anti-establishment and eurosceptic Five-Star Movement Party to rise to power in the country - they are currently polling neck and neck with the ruling Democratic Party at around 30%.

The referendum had been seen as a vote of confidence in the country’s government as the popularity of the Prime Minister wanes and the Italian economy continues to underperform. Growth in Italy has almost ground to a halt, while the country’s government debt to GDP ratio has ballooned to 135%, one of the largest in the world (Figure 4). As a result, the popularity of the Five Star Movement Party has surged in the past few years.

Figure 4: Italian Government Debt to GDP (2000 - 2016)

 

Source: Thomson Reuters Datastream Date: 05/12/2016

However uncertain the immediate political future in Italy, it must be noted that according to polls, support for leaving the Eurozone among Italians remains stuck considerably below 20%.


UK

On a fairly significant sidenote, the UK government will commence the formal two year process of leaving the European Union by triggering Article 50 at some point in 2017. The timing of Article 50 still remains unclear. Theresa May has continued to claim that this will take place no later than the end of March next year. However, the High Court ruling in November which, barring the current Supreme Court Appeal, ensures parliament must vote on the triggering of Article 50. This is likely to delay its timing and reduce the risk of a ‘hard Brexit’.

We think that both Sterling and the Euro will continue to remain susceptible to rather violent and unpredictable swings next year as specific details on the nature of the UK’s deal with the European Union begin to materialise and the outcome of the crucial European elections begin to come clear.

 

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