Global Daily – Euro political climate brightens

by: Aline Schuiling , Nick Kounis

France Politics: Macron’s party heading for big majority – President Macron’s centrist party La République en Marche (LRM) looks set to claim a wide majority in the lower house. Voters followed the momentum of last month’s presidential vote over to the parliamentary vote. Along with its coalition partner (the veteran centrist MoDem), LRM claimed 32.3% of votes cast in the first round of the lower house elections on 11 June. LRM/MoDem candidates are heading to the second round in all but a handful of constituencies. Pollsters and French media estimate the LRM/MoDem alliance will take an astonishing 400 to 450 seats of the 577 total after the second round voting on June 18. The question in a week’s time will not be whether LRM/MoDem claims a majority, but rather how large their majority will be. With a “presidential majority”, our base case assumes that Mr Macron’s government should  be able to carry out most of its ambitious reform agenda in areas like the labour market, finance and pensions. However, there remains a strong possibility that his plans will be met by widespread protest from vested interests and strikes; indeed, the leader of the country’s largest trade union has already warned Macron not to rush labour market reforms. Mr. Macron’s other hallmark project, reforming the European Union, will probably have to wait until after the German federal elections in September. (Aline Schuiling and Jean-Paul Honegger)

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Italy Politics: Declining risk on local polls, election delay – Events over the last few days point to declining Italian political risk. However, we would caution that Italy has many other challenges, and political risk may re-appear with a vengeance next year. There were two pieces of investor-friendly news over the weekend. First of all, the anti-establishment euro sceptic Five Star Movement (MSF) performed poorly in local elections. This led to expectations that the party may also do poorly in national elections. Having said that, national opinion polls still report that MS5 is neck-and-neck with Matteo Renzi’s ruling Democratic Party. Second, cross-party agreement on a new electoral law collapsed, meaning that early elections have become very unlikely. This means that the national poll will now probably come next year, and in any case by May 2018. These developments have supported Italian government bonds, but we remain cautious. Italy has a trio of inter-related economic problems: weak structural growth, a high level of government debt and a mountain of non-performing loans. This makes Italy particularly vulnerable to (expectations) of an end of the ECB’s QE programme. We expect the central bank to taper its asset purchases early next year. So even in the absence of political risk in the short term, Italian sovereign bonds will face headwinds. (Nick Kounis)

UK Politics: Minority Conservative government likely – The exception to the improving political climate in Europe is the UK. Following last week’s election, which resulted in a hung parliament, it now looks likely that the Conservative party will form a minority government. It will rely on support from the Democratic Unionist Party (DUP) to get through crucial pieces of legislation, with the details of that agreement still being hammered out. This raises the possibility that a weak and unstable UK government will conduct the negotiations for Brexit, which officially begin in just a few days. For instance, the government could easily collapse if even a relatively small number of MPs vote against the government. The DUP is pro-Brexit, but is in favour of a friction-less boarder between the Republic of Ireland and Northern Ireland, which would make immigration from the EU to the UK difficult to control. At the same time, Conservative MPs that are in favour of either a soft Brexit or a hard Brexit could make life difficult for the government. So any future Conservative (-led) government would need to walk a fine line in those negotiations. There is also a significant risk that new elections will be necessary at some point down the line. Overall, the Brexit negotiation process looks to have become even more complex. In this situation, progress might be slow and could even stagnate. Therefore the election outcome raises the risk of a ‘no-deal’ scenario. See our note UK Watch – Hung parliament raises Brexit risks (Nick Kounis)