An anti-Brexit demonstrator carries a European Union (EU) flag as he cycles outside the Houses of Parliament in London, U.K. (Photographer: Simon Dawson/Bloomberg)  

Europe's Fragility Is Exposed Again

(Bloomberg) -- So much for the return to stability.

The euro-region economy grew at its fastest lick in a decade last year and unemployment dropped to the lowest since the global financial crisis. Summer has arrived early and the feel-good factor is set to continue with Europeans glued to the World Cup soccer competition starting in Russia next month. But you wouldn’t tell from the continent’s politics.

Italy is in chaos and facing another election that will likely only strengthen the anti-establishment parties. Spanish Prime Minister Mariano Rajoy’s opponents are mobilizing a no-confidence vote and plotting an early return to the polls.

Then there’s Britain’s acrimonious Brexit talks, about to hit another critical juncture in June. French President Emmanuel Macron is pushing through economic reforms that have prompted a wave of strikes and hurt his popularity. And all while the European Union is trying to hold the line against U.S. trade tariffs, deal with a resurgent Russia and keep tabs on a potential meltdown next door in Turkey.

“Only three months ago the confidence concerning Europe was much more positive due to growth, but also the complacency about the general state of politics,” said Mujtaba Rahman, managing director for Europe at research firm Eurasia Group in London. “It’s again a testament to how quickly sentiment can change.”

It’s not that Europe is in a permanent state of crisis, but sturdy economic statistics and relative financial-market calm have served to mask disillusionment and division, especially in the south. The upshot is a sudden return of political risk for investors with the prospect of no let up in the coming weeks and months.

In Italy, President Sergio Mattarella asked a former director of the International Monetary Fund to form a government and prepare for new elections. The populist leaders expecting to take power attacked Mattarella for the collapse of their planned coalition and, suggesting an international conspiracy directed against Italy, made clear the coming campaign will focus on Europe and the euro -- for or against. The yield on Italian two-year government debt surged to the highest in four years.

Over in Madrid, Spain’s opposition Socialist Party introduced a no-confidence motion in Rajoy after a series of corruption scandals engulfed his People’s Party. The Ciudadanos party, which holds the balance of power and leads in opinion polls, pressed Rajoy to call an election or vowed to try to force one anyway.

“Things need to get worse before they get better,” said Carsten Nickel, managing director of Europe for political risk consultancy Teneo Intelligence. “If and when the market pressure returns, the political backdrop is much worse than it was six or seven years ago. It’ll be more difficult to muddle along.”

That said, we’re still a long way from the contagion that defined the European debt crisis that spread from Greece. Much has been done to mitigate the potential fallout, not least steps taken Friday to overhaul banking rules and bind the euro area more closely together.

Spain is not Italy. Ciudadanos leader Albert Rivera has called for the need for stability to “win the intellectual battle against populists and nationalists.” The economy is growing by about 3 percent and the budget deficit is set to meet EU limits for the first time in a decade. Any election will almost certainly lead to more market-friendly, pro-European policy.

Challenges from Russia, the U.S. and Turkey are to some extent beyond the EU’s control. Not so Brexit, as Britain fights its own internal war over the terms of divorce that barely moves the dial in Brussels. 

On a visit to the EU capital on Monday, Scottish leader Nicola Sturgeon said the point is approaching when the U.K. government will stop “trying to reconcile a whole plethora of irreconcilable issues” and accept a deal that keeps it more aligned with the EU.

“Reality at some point has to bite,” Sturgeon said after meeting the EU’s chief Brexit negotiator, Michel Barnier.

The question is whether a solution to Brexit or new governments in Italy and Spain can help Europe’s political leaders address deeper-seated problems, such as youth unemployment, as advocated by Macron and German Chancellor Angela Merkel. The pressure of political crisis might just help, at least when it comes to reforming the euro region.

Trouble in the eurozone immediately triggers a return of the usual critics who claim the euro project is doomed to fail, according to Erik Nielsen, Unicredit’s global chief economist.

“The currency union is incomplete and it needs to be fixed,” Nielsen said. “But no economic governance system is perfect.” Unlike deficiencies in other major economies, including the U.S., Russia and China, “the only real difference is that in Europe, we know the system is incomplete and needs fixing.”

©2018 Bloomberg L.P.

Bloomberg
Follow All The Political News In India On BloombergQuint