Even as economic confidence in the euro area reaches historic highs, a series of political risks simmering across the European Union still threaten to undermine the bloc’s fragile recovery.
The euro-area economy, aided by more than 2 trillion euros ($2.3 trillion) of bond purchases by the European Central Bank, has been gathering pace with an index of industry and consumer sentiment registering its strongest reading this month since January 2001.
But a worse-than-expected electoral performance by Angela Merkel’s party in Germany and Emmanuel Macron’s waning popularity in France have stacked the cards against a rejuvenated Franco-German core at the heart of the EU. Looming elections in Italy and a crackdown in Catalonia that fails to resolve the underlying push for greater autonomy risks affecting the euro area’s No. 3 and No. 4 economies respectively, putting the EU’s nascent recovery in doubt.
And while the ECB’s accommodative monetary policy has calmed markets and given a boost to the economy, it has also made member states complacent in pursuing necessary reforms, which could exacerbate future crises, according to Carsten Nickel, managing director at Teneo Intelligence. Once ECB policy tightens, “all the political risk will come to the forefront,” he said.
After the Catalan parliament voted to declare independence last week, Prime Minister Mariano Rajoy wielded extraordinary powers granted by the Spanish Senate to oust its separatist leadership. While Rajoy’s push to maintain Spanish unity has prevailed for now, new elections set for Dec. 21 create a further level of uncertainty over the constitutional future of a region that accounts for about 20 percent of the country’s economic output.
The EU’s fourth biggest economy is expected to hold its next elections in the first half of 2018, a poll that is highly anticipated by officials in Brussels who are anxious about its likely implications for the country’s economy and financial system. The elections are expected to test, among other stress points, the country’s ambivalent relationship with the euro, its towering debt and a troubled banking system still trying to dispose of decade-old toxic holdings.
Five weeks after Germany’s election, the four parties involved in coalition talks have yet to agree on key policies such as the euro area’s future, climate protection and immigration reform. The content of the final compromise will determine the German government’s stance on some of the EU’s most important issues, and could be a bellwether for how the bloc’s biggest debates are likely to develop. The outcome of coalition talks may also decide whether Merkel will remain dominant in the EU or if her power will be curtailed.
While the ascent of pro-euro candidate Macron was a shot in the arm for the EU, the French leader’s waning popularity in the months since his election has raised doubts about whether the 39-year-old firebrand can see through the changes he called for in Europe and at home. Macron still has time and a parliamentary majority on his side, meaning even if he pushes through some unpopular reforms he may still be able to bounce back.
Brexit negotiations remain at an impasse despite promises from the EU and the U.K. to speed up progress, as differences persist on key issues such as the final bill the U.K. will have to pay when leaving the bloc. Even though both sides have said that a fair deal is the desired outcome, EU countries agreed last week to draw up plans among themselves in case a breakthrough isn’t reached when leaders meet in December. Success or failure to agree on a Brexit deal by March 2019 will determine not just U.K. access to its biggest market but also the continued uninterrupted ability of European firms to sell goods to Britain. The four biggest euro-area economies — Germany, France, Italy and Spain — together sold about $164 billion in exports to the U.K. last year.
The Polish government has been at the sharp end of a campaign by the EU to rein in errant states, as populist leaders in Poland and Hungary have been emboldened by Donald Trump’s electoral success and Britain’s decision to quit the EU, challenging the bloc on matters such as rule of law and migration.
Meanwhile the victory by the euroskeptic ANO party in the Czech Republic’s parliamentary election earlier this month has dealt another blow to forces pushing for deeper integration in the EU and underscored the influence of anti-establishment parties in the bloc. And in another election across the border in Austria, voters paved the way for the nationalist Freedom Party to enter government, heralding a shift to the political right that’s likely to make the country a more prickly ally for its European partners.
The flow of immigrants continues to be a main concern among EU leaders, who agreed at a summit earlier this month to pursue an approach that includes “vigilance on all migration routes and readiness to react to any new trends.” This comes after the bloc grappled with the biggest influx of migrants since World War II, threatening to tear apart Europe’s visa-free travel area. While the situation is less acute than during its peak in 2015 — when there were 1.82 million instances of illegal crossings in the EU — it is still of great domestic political importance for many countries such as Austria and Germany, where migration is a key issue for voters.