Political risk in Europe is back

A congested political calendar this year, with elections in the Netherlands, France, Germany and possibly Italy in the next few months, together with renewed uncertainty over the Greek bailout programme and the UK’s decision to leave the European Union, have led investors to pay increasing attention to political developments in Europe.

France
Latest polls suggest a broadly stable situation for the first round. Le Pen making some progress in second round support, though. The Ipsos-Sopra Steria survey showed Emmanuel Macron still in 2nd position ? with a 4.5pp advantage over Francois Fillon. The center/center-left candidate is getting 23% of voting intentions for the first round of the presidential election. He is right behind Marine Le Pen who should get around 26% of voting intentions in the first round. Francois Fillon ranks third with 18.5% of voting intentions, followed by Benoit Hamon (center-left) with 14.5% and Jean-Luc Melenchon (left) with 12%. The Opinion-Way survey showed Marine Le Pen at 26%, while support for both Macron and Fillon is at 20%. The center-left candidate Benoit Hamon’s support stands at 16%, and Jean-Luc Melenchon’s at 12%. Both surveys show Le Pen winning in the first round, but so far all the surveys suggest that, whoever Marine Le Pen faces in the second round, she will lose by a significant margin (approx. 40/60%). That margin is, however, lower than in the past and the trend is a driver of market uncertainty – given also previous episodes such as Brexit and Trump’s victory.
Fillon’s case: not closed – The PNF (Parquet National Financier), in charge of tracking economic and financial delinquency, has decided in light of preliminary findings to continue its investigation of Fillon’s allegedly fictitious employment of his wife and children. The national financial prosecutor asked the police to pursue the investigation and said that the court did not envisage closing the case for now. Nonetheless, Fillon is still presumed innocent: indeed the PNF has not opened any judicial investigation. We expect this to happen only if it finds sufficient concrete evidence against Fillon. In terms of the timing of further decisions, the situation is unclear with no fixed deadlines. A key date remains 17 March, which is the last day for naming candidates for the presidential race. We would expect the PNF to take further action before that date, or wait for the elections to take their course before any new decision.
Talks of a Melenchon/Hamon alliance, but we still believe it is unlikely it can happen, in practice –Melenchon (left-wing) said he would be willing to form an alliance with Hamon (center-left) but only if Hamon stepped down, leaving him to run for president. Even if there is some overlap between the two candidates, we believe there is not enough of that amongst the voters – and no incentives from both candidates to renounce the race. (1) Melenchon is essentially anti-system, so the idea of joining the Socialist party in a joint candidacy is quite unlikely, in our view. (2) Hamon supporting Melenchon looks near to impossible, because if he does so we believe that most of the Socialist party would move to Macron. It would probably be unacceptable for a traditional party like the Socialist party not to have its own candidate. More fundamentally, the views on Europe of the two candidates appear irreconcilable – between Hamon’s support for deeper European integration and Melanchon’s anti Europe and euro rhetoric.

The Netherlands
Latest polls show far-right PVV losing ground: an Ipsos poll released on Thursday showed Geert Wilders’ anti-Islam and eurosceptic PVV party was down one seat to 27, while Mark Rutte’s liberal VVD party was up one seat to 26. These past few months Wilders’ party has been ahead in the polls and expected to win the most seats. However, the trend of the latest polls suggests that some ground is being lost, and it could even be that VVD wins the largest number of seats, after all, next month. Additionally, historically the PVV has underperformed on election day. Many voters are still undecided.
Mark Rutte and Geert Wilders will debate on television on 13 March – that is, two days before the general elections which will be held on 15 March, electing 150 members of the House of Representatives. Given that the average number of seats in each party is declining, the next government is expected to go through long negotiations with other parties in order to form a coalition. Indeed it is likely that at least five parties will be needed to ensure a majority in both houses of parliament – not different to the current state of things in the Netherlands.

Greece
Negotiations over Greece’s bailout continue. The hard deadline for financial markets is July, when €6bn of bonds mature. There’s scope, in theory, for pressure to steadily build into the summer. But time is money, and the message coming from both the Greek government and the European Commission in recent days is that there are costs in delaying an agreement. The key stumbling block remains the assessment of debt sustainability by the IMF: the IMF is asking European creditors to explicitly guarantee a reduction of the Greek debt burden, in order for it to participate in the bailout. We think that the distance between the parties can be bridged – although this might take another few weeks. The Eurogroup meeting on 20 February is probably too soon for an agreement. But a prolonged face-off, to July, with key elections in the coming months across Europe, would be unlikely, in our view.

Germany
German Centre-left SPD has gained momentum and is just behind Merkel’s CDU/CSU in polls. The appointment of Martin Schulz, former European Parliament president, as the SPD’s candidate for chancellor and successor as party head, has reshuffled the cards in German politics, challenging the widely held assumption that Merkel will win a fourth term without major obstacles. Schulz’s appointment has led to a surge in the SPD’s support to around 30%, close to the CDU/CSU’s 33%. The leading parties have been careful to leave all coalition options open at this stage. Our baseline scenario is the status quo – another grand coalition between the CDU/CSU and the SPD (‘black-red’), although a lot can change before the election in September. A Schulz-led SPD-Green-Left or a grand coalition would mark a shift in German politics towards greater fiscal expenditure and investment and a tougher stance on Brexit, alongside continued support for the EU and single currency.

Italy
Ex-PM Renzi started the process for a new congress of the Democratic Party, to elect a new leader (it seems most likely he will be re-elected) and to prepare for new elections. The timing of the congress (which will be defined this week-end, but should take place in the spring), and the need for new primaries, reduces the chances of elections in June ? with Sep/Oct 2017 or, maybe even more likely, Q1 2018 (the natural end of the legislature) as the most probable dates for elections in Italy. In our view, that makes sense, also in light of the already significant volatility possible around the timing of the French presidential elections in April/May and parliamentary elections in June: adding uncertainty to the European political landscape also wouldn’t be helpful in market terms.
Reports of break-up of Italy’s Democratic Party. The more left-leaning part of the PD is reportedly threatening to form a separate movement, unless the views of the left are included more widely in the party’s policy line. A break-up of the PD would be a major event, but likely less relevant in a context of a proportional electoral system (which is the one currently prevailing in Italy, although changes to the electoral law are being discussed). Actually, the first – very preliminary – poll on a potential break-up suggests that support for the PD would go down to 27% (from the current 31% support in the polls for the existing combined party), while the new left movement, born from the break-up, could gather 7%. So, overall, the two forces could even see their joint support increase (27% + 7% > 31%) – and they could rejoin in a coalition after the vote – again: if the proportional system is maintained.

UK
Brexit minister David Davis conceded that there may be political “ping-pong” between both Houses of Parliament. The House of Lords is set to debate the Article 50 bill on 20-21 February. If there are no amendments, the bill will become law at its third reading on 7 March. However, Labour has tabled eight amendments to the Article 50 bill, and some of them may pass in the House of Lords. That would mean the bill is sent back to the House of Commons to be looked at again, and triggering Article 50 could be delayed somewhat. However, Prime Minister May remains confident she can trigger Article 50 soon after the European Council meeting on 10 March.
Former prime minister Tony Blair made his first major political intervention since the referendum. In a speech for the Open Britain campaign, he urged opponents of Brexit to “rise up in defense of what we believe” in opposition to Theresa May’s plan of “Brexit at any cost.” He hinted at his support for a second referendum if a significant proportion of those who voted for Brexit change their minds.
Falling retail sales in January point to the first signs of a Brexit-related slowdown in spending. Retail sales fell 0.3%m/m in January on the back of a 2.1%m/m fall in December. A failure to bounce back could well point to the beginning of a broader slowdown in consumption as real incomes start to become squeezed by higher inflation due to the fall in sterling and rising fuel prices. The three months to January saw the first signs of a fall in the underlying trend of retail sales since December 2013.

Political calendar for 2017

• 20 February ? Eurogroup meeting (earliest date for a successful completion of the second review of Greek reforms if European creditors, IMF and the Greek government agree on the terms of the bailout)
• 7 March – Third reading of Article 50 bill in the House of Lords, if no amendments are made the bill will become law
• 10 March – European Council meeting in Brussels
• 15 March – Dutch election
• End of March – UK Government intended date to trigger Article 50
• 23 April – First round of the French presidential election
• 7 May – Second round of the French presidential election
• 11 June – First round of the French legislative election
• 18 June – Second round of the French legislative election
• 17 July ? €2bn redemption of bonds issued by Greece to private investors
• 20 July ? €4bn redemption of bonds held by ECB/Eurosystem exempted from the 2012 default
• 24 September – German federal election

European Economics – Credit Suisse