Wednesday, May 28, 2014

Could Anti-EU Vote Be Good for Markets?

Should the European Parliamentary elections matter for the markets?

The results leave some of Europe's mainstream politicians with bloody noses after the rise of the populist and euro skeptic vote. Perversely enough, anti-E.U. sentiment could ultimately benefit equities and bonds.

Indeed, European equity markets jumped on Monday and then edged higher again Tuesday.

In spite of the results at the past weekend’s elections, the power structure within the European Union still rests mainly with the national governments, who act through the European Commission and leaders’ summits.

Although the European Parliament enacts legislation and has supervisory powers, its impact tends to be on a micro level, relating to regulations it enacts and budget expenditures. So the direct effect of this week’s polls is likely to be marginal for markets.

The indirect effect could be more substantial.  After years of recession and austerity, it seems plenty of Europeans are saying “enough.” Behind the scenes, governments will work hard to ensure the anti-E.U. tide doesn’t gather strength, because all are fundamentally committed to the European project. But U.K. Prime Minister David Cameron, has already called other European leaders asking for them to listen to the views expressed by voters. With a general election coming up, he is likely to be especially reactive, but further moves to encourage growth among Europe's still-ailing economies could encourage governments to clear the way for the European Central Bank to launch a seriously aggressive policy response.

That is likely to start at next week's policy meeting. ECB President Mario Draghi has hinted heavily that more central bank easing would be coming, subject to economic data. Well, the data have been disappointing–growth in the single currency region was muted during the first quarter and looks to have slowed further in the second. Inflation is still too low and credit provision continues to contract.

Indeed, in a speech on Monday, Mr Draghi gave markets another nudge that the ECB was planning further action, warning about the risks of the euro zone sliding into a deflationary spiral.

E.U. governments know that without economic recovery the anti-E.U. tendency will only grow. To that end they’re likely to ease political roadblocks that have so far hamstrung the ECB. This could finally tilt the central bank towards radical solutions, such as a large asset purchase program–known as quantitative easing–or to negative interest rates. To the benefit of both the equity and bond markets.


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