For once, the European Parliamentary elections, which used to be a political sideshow, really matter – and not just because of Brexit. In our view, the outcome of these elections will have a bigger impact on European politics, and therefore financial markets, than ever before. It will directly influence the appointments of leaders of key European institutions and indirectly operate as a powerful political signal in major European economies.
Why Is 2019 Different?
The fallout from the Global Financial Crisis and the subsequent Eurozone sovereign debt problems have led to major electoral gains for Eurosceptic parties over the last decade. Far-left, far-right and other Eurosceptic parties boosted their collective share of European Parliamentary seats from 16% to 25% from 2009 to 2014. These parties tend to do disproportionately well in European elections as the perceived stakes and turnout are relatively low.
Despite a holding quarter of available seats, these parties have previously been mere ‘noisemakers’ as there has always been a governing coalition among mainstream European parties to dictate the agenda and outcomes. However, current polling suggests that anti-mainstream parties are likely to garner above 30% of the 751 seats in this year’s election. While this may seem far from a majority, just winning over a third of the seats would be enough to bring about a major change in parliamentary business and EU politics. Figure 1 shows the current polling of parties in the next European Parliament.
Anti-Mainstream Parties Could Disrupt EU Decision-Making
If anti-mainstream parties take a large share of the seats, parliamentary arithmetic would require all mainstream blocs to cooperate, which makes reaching political compromise harder and slows down policymaking. Moreover, for certain decisions, a two-thirds majority is actually required, so anti-mainstream parties could delay or paralyze important decision making even if they do not operate as a cohesive political faction.
It is important to remember that the Parliament has a formal role in most of the key dispute areas: for example, the Parliament must approve any Brexit deal and the future UK-EU relationship. Moreover, the rule-of-law violations of Poland and Hungary require two-thirds majorities’ approval of the Parliament for action to be taken. Finally, the response to Italy’s looming debt and fiscal problems within the Eurozone will be partly shaped by the composition of the Parliament.
Direct and Indirect Impact Could Be Significant
The immediate impact of this outcome would be on the nature of European appointments. The Parliament formally approves the appointments of the Commission, foremost its president. The next Commission president will shape the EU’s ability to drive reforms, particularly in relation to the Eurozone and the fiscal pact.
The results of the Parliamentary election could not only change the fortunes of specific Commission presidential candidates (and commissioners), they could also ripple through to other EU appointments. For markets, the most important would be the next European Central Bank president, scheduled to take office on 1 November 2019.
If, for example, the outcome of the Parliamentary elections leads to a Finn or a German becoming European Commission president, in practice, this would exclude either nationality for the ECB presidency. This in turn would raise the chances of a more dovish incoming ECB president, given that the most hawkish contenders come from Germany and Finland. The final outcome is not only dependent on election results, but on political deal-making in its aftermath. A strong showing for Macron’s ALDE grouping would probably lead to a compromise candidate for Commission president.
In addition to influencing EU appointments, the Parliamentary elections could have significant ramifications for national governments as an indicator of the public mood and could trigger surprise policy corrections. Countries with elections on the horizon are likely to be most vulnerable to political change. Notable scheduled elections in 2019 include Greece, Portugal and Poland while Italy is likely to face a snap election before the year end. If the incumbent Conservative party in the UK suffers severe losses in the European elections, it too could see a No Confidence vote in the government, supported by its own MPs, and a General Election. Finally, for France and Germany, the Parliamentary elections are something of a half-time verdict on current governments and could profoundly shape their reform appetite at a national and European level.
Implications for Markets
Markets are likely to respond more to the broad signal of these elections than the precise outcome. They are currently pricing for anti-mainstream parties to take about 30% of the seats. Yet if they outperform the polls and capture more than a third of the seats, the procedural impact is not fully understood. It would materially worsen the policy environment and reduce the likelihood of much-needed Eurozone reform. Any major deviation upwards or downwards is likely to generate a significant shift in pricing, particularly in the Euro exchange rate (versus non-European G10 currencies), simply based on sentiment.
Depending on the implications for the ECB presidency, the Euro could move more strongly. Similarly, sovereign bonds are likely to respond to overall sentiment as well as any shift in monetary policy horizon. And finally, European equities with high policy exposure, e.g. Italian banks, could also be very sensitive to any re-evaluation of the environment. These would all move up if mainstream parties outperform expectations or downwards if they underperform.
If these elections cement the rise of populism in the EU, as expected, then this additional level of uncertainty is likely to play into longer-term investor calculations about future European growth and indeed the survival of the Eurozone.
Appendix: How the EU Parliamentary Elections Work
The Parliamentary elections are the only direct election of EU representatives by the public. In contrast, all other EU roles are appointed indirectly through the various national governments (themselves elected). Originally, the Parliament had minimal real decision-making power, but reforms have now vested it with significant oversight and appropriations powers, akin to national parliaments. In practice, this means the Parliament must approve EU treaties, budgets, legislation and appointments to the executive body, the European Commission (EC).
The electoral system is one of proportional representation, where each national public votes for the composition of its share of parliamentarians. The respective national parties each are members of a transnational European political bloc, resembling their political identity in domestic politics, e.g. conservatives, liberals, socialists, etc. The Parliament is highly fragmented among eight to ten blocs, plus several independents. Since 1999, the conservative bloc (EPP) has been the largest bloc and has therefore ensured that conservative politicians lead the key EU institutions, even if it has governed in conjunction with other centrist blocs. President Macron of France, whose LREM party may coordinate with the EPP, is opposed to the previous leadership election process that selected the incumbent and would prefer the heads of state to choose the Commission president.
The views expressed in this material are the views of Elliot Hentov and Esther Baroudy through the period ended 05/20/2019 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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