With the European Parliament elections taking place this week, Millennium Global’s Macro Economic and Research team are pleased to release a research note examining the risks and implications for the Euro.
In summary, we believe the short-term impact is likely to be benign although there may be a negative immediate effect on Euro sentiment, specifically, if a populist victory in Italy revives market concerns about unsustainable government debt dynamics. In addition, the outcome of the EP elections may affect the outlook for institutional reforms of the EU/EMU over the longer term and indirectly influence the choice of the next ECB governor this year. Both developments could potentially carry negative consequences for the Euro over the medium term especially if this were to weaken the ability of the ECB to react to the next global downturn.
We think the direct implication of the EU elections for the Euro are benign, given that mainstream parties are likely to be able to form a working majority in the EP. We doubt support for populist parties will be large enough to block legislation.
If polls have underestimated the share of seats that populist parties will win, predicted at around 30% of total seats, then the downside risk to sentiment on EUR will increase.
The indirect effects of the elections on national politics are likely to be of more immediate market concern. For example, the elections may prompt political instability in Italy/Spain and slow reform momentum in France.
We see most significant risk in Italy. Italy’s budget is already at risk of breaking EU rules and Deputy PM Salvini has made European fiscal constraints a central issue for his Lega Party campaign. A strong performance across the EU for Lega and the ‘Salvini Alliance’ may lead to more confrontation between Italy and the EU’s executive branch, the European Commission (EC), which will be negative for the Euro.
The outcome of the EU election will also indirectly affect the choice of the next ECB governor. If Manfred Weber does not become the EC president, it will be more likely that his fellow German Jens Weidmann will be the next President of the ECB in place of Mario Draghi. He has previously opposed QE, so this will create uncertainty on how the ECB may respond to an economic downturn in the future.
Helping mitigate these risks is widespread short positioning in EUR/USD, as indicated up by our proprietary Millennium Global FX Positioning index. Balance-of-payment dynamics for the Euro have also improved as financial outflows have declined. As such, our strategic base case for a broadly range-bound EUR vs. the USD remains unchanged.
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