GIC Board Member, J Paul Horne’s report on the results of the European Parliamentary elections was published by The European Institute at the University of Maryland (www.europeaninstitute.org/ ) and is used with permission.

Markets are reacting negatively to the economic implications of the European Parliamentary (EP) elections held in late May. The results in most of the 28 European Union (EU) states sent a decidedly mixed message on who and how voters want to manage EU and euro zone (EZ) monetary and fiscal policies. Symptomatic of market nervousness was the historic low yield on Germany’s 10-year government bond, as investors fled to what is considered Europe’s safest investment. The “bund” yield closed at minus 26 basis points (-0.26 percent) last Friday (June 7), even though the negative yield means investors pay the German government to protect their capital.

The flight to such “safe” investments, plus the European Central Bank’s (ECB) continuing easy monetary policy, means an extraordinary quantity of European government bonds now have negative yields. Including Japan’s large amount of negative yield government bonds, global bonds yielding less than zero now total nearly $11 trillion as the Bloomberg chart (Figure 1) below shows—a clear indicator of market angst.

Figure 1: Global Stock of Bonds with Negative Yields (2017─2019)

Source: www.Bloomberg.com (accessed on May 29, 2019).

Other symptoms of economic distress include the extended slide of the euro (now in its 21^st year) against the dollar, which began in early 2018; and new weakness of the Euro STOXX 50 index of blue chip EZ companies’ share prices. These help explain the decline in the EZ Purchasing Managers’ confidence index (PMI) just before the elections. Markit’s chart (Figure 2) below compares the high correlation between its EZ PMI and EZ GDP between 1999 and May 2019. This year’s decline points to further weakness ahead, a forecast strengthened by the EP election results.

Figure 2: IHS Markit EZ PMI and GDP (1999─2019)

Source: https://www.markiteconomics.com (accessed on May 29, 2019).

The growing fragmentation of Europe’s traditional post-WWII political parties, and rise of euro-skeptical parties, raises doubts about future economic policies. A total of 751 European Members of Parliament (MEPs) were elected to five-year terms (to 2024) by 51 percent of over 400 million eligible voters, a much higher participation rate than 43 percent in the 2014 elections. But the results were so mixed that there is no clear consensus whether European union will be strengthened, as promoted by German Chancellor Angela Merkel and French President Emmanuel Macron; or weakened as increasingly vigorous populist-nationalist-euro-skeptic parties insist.

 
The elections will, however, force some important immediate changes. The center-right and center-left parties that controlled the European Parliament for decades suffered losses. The European Peoples Party (EPP, in blue, see Figure 3) lost 38 seats but remains the biggest party. The Progressive Alliances of Socialists and Democrats (S&D, in red) lost 34 seats but remains the second largest party and dominates Spain and Portugal. The Alliance of Liberals and Democrats for Europe (ALDE, in orange) gained 17 seats to be the third largest group. The Greens (not shown on map) picked up 17 seats to be the EP’s fourth largest party.

Figure 3: European Parliament Party Leading in Each EU-member country
(Following 2019 European Parliament Elections)

Source: https://en.wikipedia.org/wiki/2019_European_Parliament_election (accessed on June 2, 2019).
Notes: In countries where some parties have had the same number of seats, the party with the most votes is displayed.

 
The Euro Conservatives and Reformists (ECR, in dark blue) lost 13 seats but is the fifth largest and Euro-skeptic party. The Europe of Nations and Freedom party (ENF, in black) gained 22 seats to rank sixth. The ENF represents the euro-skeptical and nationalist parties who came in first in France (Macron’s party losing by 0.1 percent to the Front National) and Italy where the far-right nationalist Lega won the most votes to be Italy’s largest party. Last of the Euro-skeptic groups is the Europe of Freedom and Direct Democracy (EFDD, in teal), dominated by the British Brexiteers, which gained 12 seats for a total of 54.

These results mean a new majority coalition must be formed by the weakened but pro-Europe EPP and S&D, supported by the Greens, to keep control over EU legislation and the EU budget.[1] That new coalition must then make crucial decisions affecting the EU’s future, including the approval of the new European Commission (EC) president (nominated by the European Council which must also elect its own president[2]), as well as the other 27 EC commissioners.[3] As the EU’s executive arm, the EC proposes and implements the EU’s current and long-term budgets, spending, laws, and regulations.

Most importantly for financial markets and the economy, the European Parliament must approve the European Council’s nominee to succeed European Central Bank (ECB) president Mario Draghi, whose term ends October 31, 2019.[4] The new ECB president will, of course, be instrumental in determining future EZ monetary policy. Markets are all too conscious that Draghi’s “do whatever it takes” pledge to save the euro in 2012 succeeded and must be maintained by his successor if the EZ is to avoid serious economic turbulence.

The process for choosing these key leaders began with the European Council’s closed-door discussions on May 28. The Council will next meet June 20─21 to agree on nominees for the EC and ECB; as well as their own president and the EC’s High Representative for Foreign Affairs. The new European Parliament will first meet July 2─4 in Strasbourg to elect its own president, then again July 16─18 to endorse the European Council’s choice for a new EC president, an iffy proposition during Europe’s principal holiday season. Making it even iffier, the UK’s new leadership will, after taking power by late July, probably decide when and how to exit the EU. This means the bloc of 73 British MEPs will complicate EP voting on these key EU positions. When the EC president is eventually agreed, probably in late summer, he/she will name one commissioner from each of the other 27 member states and assign their portfolios. The European Parliament will vote October 22─24 to confirm the new EC. On November 1, the new EC takes office and Draghi’s successor starts at the ECB in Frankfurt.

Markets worry that if the new EPP-S&D plus Greens coalition is not solid on these key decisions, the populist-nationalist-euro-skeptic MEPs, who control 25 percent of EP seats (up from 20 percent in 2014) could, theoretically, derail these key nominations or pro-European policies desired by the governing coalition. But sharp differences exist between the euro-skeptic and populist-nationalist parties and should limit their ability to thwart the key nominations.

Horse trading among the largest EU countries determines the choices for the new presidents of the European Council, EC and ECB. This means sequencing of their nominations and approval by the EP is important. If, for instance, a German is named president of the European Council or Commission, the posts to be filled first, the chances of a German heading the ECB are reduced.

Conversely, if non-Germans are selected for the Council and EC, Germany’s Jens Weidmann, Bundesbank president, might be named ECB president. A staunch opponent of “mutualization,” the sharing of EZ countries’ debt, Weidmann also insists on belt-tightening by EZ countries with excessive deficits (including France); is critical of consolidating the EZ banking system; and resists calls for Germany to use its large budget and current account surpluses to stimulate the European economy. How he would have the ECB react to slowing economic growth in Europe is unclear.

At a national level, the EP election results are seen by markets as leading indicators of political trends that will influence national fiscal and economic policies in key EU countries.

In Germany, the relatively good showing by traditional parties, failure of the far right and left parties to gain as much as feared, and the high 61 percent turnout, means Berlin is likely to win key EU positions. Nevertheless, Germany’s center-left SPD, a member of Merkel’s grand coalition, plummeted to 15.8 percent of the European Parliament vote from 27 percent in 2014; and Merkel’s center-right CDU-CSU sagged to 28.9 percent from 35 percent in 2014. This persuaded the CDU-CSU-SPD coalition government to keep Merkel in office until 2021. The Greens became Germany’s second largest party with 20.5 percent (double their 2014 vote), ensuring a significant voice in future policy-making and possible participation in the government. The AfD (Alternative for Germany) extreme right party failed to advance as much as feared, but won 11 percent (vs. 7 percent in 2014) and will remain the main opposition party.

The UK’s Brexit imbroglio meant British voters elected 73 MEPs (third after Germany and France), further confusing the outlook for the UK and EU. The new Brexit deadline is October 31 but a new, possibly very euro-skeptical British prime minister could take the UK out of the EU before then. PM Theresa May resigned on June 7 but will remain as caretaker PM until the Conservative Party selects a new prime minister in late July.

The newly elected British MEPs will participate in the first plenary session of the European Parliament on July 2. The new Brexit Party’s 29 MEPs, the largest group of the 73 British MPs, will sit in the Europe of Freedom and Direct Democracy political grouping of right-wing Euro-skeptic parties. The UK’s future role in the EU thus remains murky indeed. If and when Brexit occurs, the European Parliament decided last year to cut the total number of MEPs from 751 to 705.

The UK is a growing unknown for financial markets and Europe’s economy, which already appears to be weakening. The financial shift from The City in London to the Continent is also accelerating. The volume of euro-clearing transactions in Paris is growing rapidly while the share in London, once the principal euro-clearing center, is declining. The OECD forecasts that GDP growth in the UK will slow to under 1 percent this year, as capital spending and private consumption weaken because of Brexit. With the U.S. president, on an official visit to London this week, urging the UK to leave the EU even without a Brexit deal and threatening to expand his tariff war to European car exports, British economic prospects are decidedly negative.

Italy is a major political question mark with significant implications for its economy and renewed confrontation with the new European Commission over its expansionary fiscal policy. The rightwing Lega (League) won 34 percent of the vote and its coalition partner the Five Star Movement won 17 percent for a combined 51 percent of total Italian votes. Deputy PM Matteo Salvini, the Lega’s charismatically euro-skeptic leader, might decide to hold an early election, although he said he would focus on stimulating the economy. A sharp increase in the spread between the yield on Italy’s 10-year government and the German bund, belies market concerns.

In April, Salvini launched the “European Alliance of People and Nations” as a new coalition of right-wing populist, hard euro-skeptic and anti-immigration parties. It was joined by most of the members of the outgoing Europe of Nations and Freedom group (including Lega, the French National Rally, Austria’s Freedom Party and the Dutch Party for Freedom) as well as some former EFDD (Alternative for Germany) and ECR parties (Danish People’s Party, Finns Party). But pre-elections squabbles caused a number of these parties to split from Salvini’s alliance, which now seems ineffectual.

France’s President Macron’s party paid the price of six months of very public conflict with the “yellow vest” demonstrators protesting, often violently, his pro-business and austerity measures. The far right and anti-euro Rassemblement National (formerly the Front National) won 23.5 percent of the vote, 0.1 percent ahead of Macron’s LREM party in coalition with the MoDemo, another centrist party. The Socialists who governed for much of the last 30 years, were crushed to 6.2 percent and the Republicans (ex-Gaullists), another formerly dominant political force, plunged to 8.5 percent. The ecologists and Greens won 13.5 percent.

Macron’s weakened political position does not threaten his control of the National Assembly where the LREM has a strong majority. But it raises questions about his ability to push his proposals to strengthen European union. Since his principal ally, Chancellor Merkel, is also under similar pressure at home, it may be difficult for them to push much-needed EU reforms such as fiscal union, consolidation of the banking sector, boosting the joint EU defense force, and responding to President Trump with a unified voice. They may also find it difficult to agree on the key EU leadership positions.

Conclusion

The weakened position of Europe’s traditional parties in the European Parliament reflects voters’ growing antagonism toward those parties’ economic and social policies of recent years, plus the fear generated by the growing immigrant problem. Given that the EU’s top leadership must be changed during the next few months, when European voters seem less and less willing to approve pan-European cooperation, the negative implications for Europe’s future monetary, fiscal, and economic policies are considerable.