Bill Witherell is Cumberland Advisors' chief global economist. He joined Cumberland after years of experience at the OECD in Paris. The views and opinions expressed in this piece represent only those of the author and are not necessarily those of S&P Global Market Intelligence.
The election in the U.K. is now less than two weeks ahead, on June 8, followed three days later by the first round of the French parliamentary election on June 11, with the second and final round on June 18. An election in Italy, which many did not expect to occur until early 2018, now may well happen as early as September or October this year. Each of these elections has important implications for markets.
The U.K. election had looked like a sure thing for Prime Minister Theresa May and the Conservatives, who at one point enjoyed a huge lead in the polls. May called for this "snap election" to strengthen her hand in the Brexit negotiations and enhance the position of the Conservative Party. However, the polls have narrowed considerably in recent days, with measures of the Conservatives' lead over the Labour Party and its leader Jeremy Corbyn varying between five and 14 percentage points.
May had to make a U-turn on a central element of the Party’s manifesto: a poorly constructed and insufficiently vetted proposed reform of the funding system for social care for the elderly, which quickly came to be known as the "dementia tax." Labour seems to be getting some traction from its proposals to substantially increase government spending, raise taxes on companies and the rich, and re-nationalize the railroads, the Royal Mail, and water companies. Also, there has been increased attention on the prime minister’s weak understanding of economic and business matters. While the Conservatives still have a lead and may well still achieve a strong victory, investors now have to consider a wider range of possible outcomes, including a weak victory by the Conservatives that does not strengthen the party’s present 12-seat majority, a result in which neither main party wins a clear majority, or an upset victory by Labour.
A strong victory for the Conservative Party with a gain of 100 or more seats would give May more leeway to make compromises and negotiate a smooth Brexit. Such a result would probably be the most positive for markets. A lesser victory but one that still strengthens the Conservative majority would also reduce uncertainty risks, but to a lesser degree. A victory with no gains would show that calling the snap election was a mistake and weaken the ability of the Conservatives to move their program through Parliament, including those reforms needed for Brexit and sought by business.
Should neither party win a clear majority, uncertainty risks would surge, as efforts to put together a coalition government could take some time, and Brexit negotiations would be set back. A coalition between Labour and the Liberals might be the most likely eventual result of such an election outcome. An upset victory by Labour would not be well received by markets. Public debt and the government deficit would be likely to surge; government borrowing costs would rise; higher taxes would hit businesses; and sterling would likely tumble. Investor uncertainty would be high. The ability of Corbyn to lead an effective negotiation and achieve a good Brexit result for the United Kingdom looks doubtful to this writer.
The new French President, Emmanuel Macron, is building on his strong May victory. His new party, Republic on the Move (LREM), is now leading the polls for the June 11 first round of the legislative election, with 31% in a Harris Interactive/LCP poll. The far-right Front National was second with 19%, and the conservative Republicans were third with 18%. Macron appears to have helped the LREM's prospects with his selections of ministers for his government. Since his party is new, he needed to achieve a political balance, drawing upon some talent from the right, some from the left where he has his roots as a former Socialist minister, and some highly competent nonpolitical figures. He also achieved a balance between male and female ministers. Perhaps his wisest move was to appoint Édouard Philippe, mayor of Le Harve, the center-right former right-hand man to Alain Juppé, a leading member of the Republican Party.
Macron clearly needs to muster support from the Republicans if he is to achieve his ambitious plans for France. Despite the indications of the polls, the election outcome is by no means certain, particularly because the leading party is so new and inexperienced. Markets would welcome a strong result for Macron. A weak result would certainly raise concerns. A Republican victory, while surprising, would also likely be seen as positive by markets. An upset win by the Front National would elicit a very negative market response, not only in France but across Europe and beyond.
Italy, the third-largest economy in the eurozone, with the largest external debt, is suddenly facing the prospect of possible elections as early as September. This is because Matteo Renzi, who leads the center-left Democratic Party, has begun talks with the opposition parties about voting reforms that could make possible an early election. Without election reform, however, the current center-right government would most likely continue until early 2018, when the expiration of the current legislature will necessitate a new election. Investors appear to be concerned about this election, with good reason, particularly in view of the strength of the populist, Eurosceptic Five Star Movement. While a victory for the Five Star Movement would be the most negative result by far for markets, a hung parliament with no clear result would also depress markets.
Markets are relatively relaxed about the outcome of the German federal election on September 24. Angela Merkel’s Christian Democratic Union Party (CDU) looks to be the very likely winner in September, following strong victories in state elections over the Social Democrats (SPD), led by Merkel's main challenger, Martin Schultz. The German economy is strong, with unemployment at just 4.1%. Merkel is seen as a strong leader of Europe and indeed a world leader. It is uncertain whether the CDU will be able to form a government on its own or will have to form another "grand coalition" with SPD, bringing together Germany's two largest parties. While markets would likely respond most strongly to a center-right CDU victory, a continued coalition with the center-left SPD would not raise concerns. Both parties strongly support Europe and the euro, global trade, and the economic policies that have been so successful for Germany. The far-right populist Alternative for Germany poses no threat.
In sum, the upcoming elections in the U.K., France, Germany and possibly Italy could all result in victories for market-friendly governments that would strengthen prospects for European markets in the remainder of 2017 and beyond. That outcome is the most likely for Germany, still likely for France and the U.K., but disturbingly uncertain for Italy.
Sources: Financial Times, New York Times, Reuters, BBC, Deutsche Welle, and The Economist.