Spain Heads Back to the Polls Ensuring Euro Exchange Rates Face a Spring of Political Angst

Image © curto, Adobe Stock

- Political upheaval to keep the Euro depressed

- May elections likely to incite special volatility

- Deeper European banking and fiscal union unlikely in current climate

European political turmoil is a key market risk in 2019 and this will keep the Euro depressed, says Thanos Papasavvas, founder and CEO of ABP Invest.

“My concern is politics in Europe, and generally I think there is going to be more volatility. I think we are going to move away from the excessively low volatility of 2017 and we will be moving into a more elevated volatile environment,” says Papasavvas.

The call by Papasavvas comes on the day Spain’s prime minister, Pedro Sánchez calls a snap election for April 28 after Catalan secessionists joined rightwing parties in rejecting the socialist government’s national budget earlier in the week.

The country’s third general election in less than four years was seen as an inevitability following Sánchez’s defeat on Wednesday and will force investors to start pricing a political risk premium into European assets, including its currency.

The Euro is under pressure amidst the headlines with the Pound-to-Euro exchange rate climbing 0.4% to 1.1371 and the Euro-Dollar exchange rate falling 0.13% down to 1.1279.

“Between doing nothing and continuing without the budget and calling on Spaniards to have their say, I choose the second. Spain needs to keep advancing, progressing with tolerance, respect, moderation and common sense,” Sánchez said in a televised address to the nation following a cabinet meeting. “I have proposed to dissolve parliament and call elections for 28 April.”

For markets, the emergence of the far-right VOX party is of concern, the ascension of which appears to have roots in the tensions surrounding Catalonia. 

"We argued before that the Catalan secessionist issue was here to stay. And it is pretty much dominating, whether explicitly or implicitly, most of the political and policy debate these days. Nationalism on both sides keeps gathering steam," says Chiara Angeloni, Europe Economist with Bank of America Merrill Lynch Global Research in Milan. "The secessionist movement is partly responsible for the appearance of the far-right party, VOX."

VOX is a nationalist movement that has aligned closely with France's National Front, pursuing an agenda for, among other things, less decentralisation of Spain, promotion of the national symbols and values, undoing the law on gender violence, a tougher stance on illegal immigration including suspending Schengen until there are better controls, and building a wall in Ceuta and Melilla.

Additionally, it argues for a more aggressive response from central government towards regional nationalism and, in particular, the secessionist push in Catalonia. It has called for, again, applying article 155 to Catalonia but with tougher implementation (Article 155 of the constitution allows the Spanish government to take control of a region under some specific circumstances).

"The party is also calling for redefined European rules that take power away from Brussels institutions and return it to the Member States. So it does not have an explicit Eurosceptic message, but implicitly some of the measures it proposes would run contrary to the current European framework," says Angeloni .

Angeloni notes the Spanish political arena has gone from a simple two-party system, with a centre-left party (PSOE) and a centre-right party (PP) dominating the landscape and shaping governments, to one with five parties polling above 10% and which is increasingly polarised (moving away from the centre).

Looking beyond Spain, European parliamentary elections scheduled for May are arguably of greater concern to investors eyeing the rise of nationalism in individual member states which would seek to draw power away from the ‘centre, and this will weigh on the Euro.

As a result, "I expect the Euro to, therefore, start weakening, and the spreads to start widening versus the bunds,” says the CEO of ABP in an interview with Bloomberg News. "The area which I think the market is underpricing is the risk of ‘Europe’. I believe that power is going to be moving away from Brussels over the next decade back into the national areas with Merkel and Draghi not there to control and drive the centre. I believe the parliamentary elections in May are going to be vitriolic in terms of politics - we have already seen a little bit of that in the spat between France and Italy,” he adds.

Italy's ruling League party lawmaker Claudio Borghi has also said today the upcoming EU elections are the last chance to change Europe, otherwise Italy will have to leave.

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Another analyst who sees volatility on the horizon caused by the political situation in Europe, is Mike Gallagher, the managing director of macro and strategy at Continuum Economics.

“I think really if you look at European politics, we will see a shift towards more populist parties in the May elections, but that might not be enough this year to actually transform the political landscape in Europe,” says Gallagher.

“They will try and maintain the status quo. I think the bigger threat of political upset comes once we get into the next decade and then we see the next German election, but for now, I think we will see turbulence around May but the status quo returning,” he adds.

A move to greater fiscal union is unlikely because of the “fractious” political situation. Even the hope and expectation of greater consolidation within the European banking sector is only likely on a domestic level at the moment.

“The political environment in Europe is a little bit fractious at the moment, as we know. Tension between Italy and France being an example of that. Consequently, I don’t think there is momentum of that cohesion towards a pan-Eurozone banking consolidation at the moment,” says Gallagher.