Liberté, égalité, Frexit? (Archived)

France’s unruly elections demonstrate how the sources of political risk facing the eurozone are shifting in 2017 from the European Union’s peripheral member states to those at its core.

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For much of the past decade, political risk in the eurozone has bubbled up from the so-called peripheral countries such as Greece, Ireland and Portugal. In each case, bailouts from the European Union and International Monetary Fund stabilised sovereign debt crises, helped keep contagion in check and limited financial market fallout to occasional outbursts of volatility. Now, however, the focus of geopolitical risk concerns in Europe has shifted to the willingness of citizens of the bloc’s largest economies to continue to support the “ever closer union” called for in the 1957 Treaty of Rome upon which the EU’s legal foundations rest.

In 2017, France will hold national elections that are likely to replace the current socialist government, a stalwart backer of the euro and ongoing European integration. Later in the year, German voters will also cast ballots in federal elections. In both countries, polls show diminishing faith in current leaders’ ability to address challenges including chronic unemployment and ongoing mass immigration from outside Europe. The decline of the elites has created an opening for maverick political entrepreneurs who emphasise national, rather than pan-European concerns. Some, like Marine Le Pen, leader of France’s populist, eurosceptic Front National (FN) have called for a British-style referendum on leaving the EU. That scenario may seem farfetched but if it did go ahead it could have more significant market and economic implications than the UK’s vote to do so.

Rowena Geraghty, EMEA sovereign analyst at Standish1, views a Frexit as unlikely but notes: “Unlike the UK, France is one of the founders of the European project. France now serves as the only decent counterweight to Germany in the EU and its exit would have a more profound impact than the UK’s. Market volatility could return to levels last seen before European Central Bank (ECB) President Mario Draghi pledged to do “whatever it takes” to save the euro in 2012. Peripheral governments’ borrowing costs would materially increase, concerns regarding banking systems could resurface in some countries.  The potential for recession would become a talking point.”

In the short-term, however, despite those geopolitical risks, Standish still expects the eurozone economy to grow by 1.2% in 2017, down slightly from the 1.5% growth rate for 2015 and 2016. This forecast is somewhat below the ECB’s growth forecast and reflects what Standish sees as some evidence of stress in confidence, such as underwhelming manufacturing PMIs. Standish also expects eurozone inflation to tick up to 1.0% in 2017, from 0.1% in 2015 to 0.2% in 2016, prompting further easing from the ECB beyond the scheduled end of its asset purchase programme in March.

France holds its all-important run-off election after a series of two-round primaries. Familiar names including ex-prime minister Alain Juppé are in the mix. With a dozen candidates competing in primary elections for the nominations of the Republican and Socialist parties, the lack of both a strong incumbent and a single credible challenger creates an opening for those such as Le Pen, although this is not our base case, says Geraghty.

Former economics minister Emmanuel Macron is another wild card she adds. The former investment banker has never run for office but has drawn attention by challenging French socialist institutions such as the 35-hour work week and the country’s vast public sector. Macron’s entry into the race as an iconoclastic candidate without party could draw support away from both Socialist and Republican candidates and create a potential opportunity for the FN. In 2002, an unusually crowded field of candidates fragmented the electorate.

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Ominous historical echoes notwithstanding, Geraghty expects Juppé, one of France’s most popular politicians, to emerge victorious and the spectre of Frexit to fade. Even without Le Pen pushing France out of the EU, though, a strong showing by the FN could conceivably push a centre-right winner such as Juppé to adopt a more eurosceptic policy stance. This would have repercussions for Germany, the other nation at the heart of the EU, as well as for France. “A more assertive French president - Hollande is almost so quiet as to be extinct - could lead to  livelier debate with Germany and EU institutions over policy, especially on immigration,” says Geraghty.

Germany holds federal elections later in 2017, but state elections in 2016 suggest Chancellor Angela Merkel has her own challenges. In Merkel’s own Mecklenburg-Vorpommern constituency, the governing coalition of her Christian Democratic party (CDU) and the Social Democratic Party (SPD) faced the insurgent Alternativen fur Deutschland (AfD) party. Merkel campaigned for her party, and despite insisting "Wir schaffen das" ("We'll manage it"), the CDU came third with 19% of the vote behind the SPD with 31% and AfD with 21%.2 The CDU’s weak showing hints at Merkel’s unpopularity and AfD’s relatively strong result suggests many Germans want alternatives to open borders and further European integration.

Even if they do not win power themselves, political insurgents such as Le Pen and AfD may exert pressure on those who will, raising questions of globalism versus nationalism and 'Europe'  versus 'Frenchness' and 'Germanness'.  The 2017 elections may be another step in the realignment in the politics of core Europe; not between right and left or east and west but between the pro-globalisation governing elites and a middle class that no longer sees its interests being represented by that elite. 

What to watch in 2017

  • 23 April: First round of French general election.
  • 7 May: French general election run-off.
  • September/October: German federal election.

1. Investment Managers are appointed by BNY Mellon Investment Management EMEA Limited (BNYMIM EMEA) or affiliated fund operating companies to undertake portfolio management activities in relation to contracts for products and services entered into by clients with BNYMIM EMEA or the BNY Mellon funds.
2. The Guardian: It’s too soon to write Merkel off’, 5 September 2016

This is not investment advice. Regulatory Disclosure