Financial Market Developments in light of the recent electoral events. Is any part of Europe facing a financial crisis?

The recent elections in the EU, the UK, and France; what impact are the results likely to have on financial and monetary policy?

Before these elections, mainstream commentators worried that polling was predicting a shift to the right. This would unsettle financial markets, so the narrative went, because conservative leaning governments would translate into reduced ‘stimulus’ upon which both financial markets and member state budgets rely. In our view, their fears were and continue to be a little overstated.

The results of the EU Parliamentary elections in early June duly showed a tiny drift to the right, with the European People’s Party (EPP) proclaimed the ‘winner’ with a 21% share of the total vote, a gain of only one seat. It is hard to describe this as a ‘power shift’ that will lead to “profound implications for the future economic policies and stability of the EU.” ¹

France and the EU

Turning to France, the rise to prominence of the left-wing coalition called NFP (National Popular Movement) produced even stronger fear-mongering, and from an eminent establishment figure, outgoing finance minister Bruno Le Maire. NFP’s demands that the retirement age be put back to where it was before the protests started, that minimum wages be increased and that the highest income tax band be raised to 90% prompted M Le Maire to claim that France faces a ‘financial crisis’.² But does it?

It is true that France’s public debt numbers are in poor shape, so much so that in mid-June the European Commission announced that France would be subject to “Excessive Deficit Procedures” because it is presently running an annual budget deficit of 5.5% of gross domestic product (GDP). Although five other member states were cited in the same announcement (Italy, Belgium, Hungary, Malta, Poland and Slovakia), it is likely that the Commission’s announcement was tactically timed – shortly after President Macron called the elections – as a warning to France against further largesse such as the NFP now demands. However, the NFP coalition is only one month old, consists of five different parties who have vehemently disagreed on multiple issues, and only won 31.5% of seats in the National Assembly. The chances of its demands being enacted, especially given the power of the European Commission, look minimal.

France’s financial markets seem fine. Sure, bonds and stocks fell a little after the surprise June 9 election announcement, presumably in response to stability concerns. Markets then rose slightly after the first voting round, in relief that the right leaning National Rally party of Mme Le Pen had performed less well than predicted and was unlikely to gain outright power. Had she won enough seats to form a government after the first round, ironically the market response to a new and stable government would have been jittery. In the week after the second voting round France’s financial markets showed a little volatility but remained basically stable, pleased that the new government would be restricted by coalition compromises. Markets are shrugging off France’s credit rating reductions, two in the past six months by Standard & Poor’s. At around 50 basis points above the German Bund, the spread featured by the French government bonds does not ring alarm bells.

United Kingdom

Contrasting France, there is no gridlock in the UK for the foreseeable future with the Labour Party having won 63% of Westminster’s seats. The silver lining is that the Conservatives came second with all the perks of qualifying as His Majesty’s opposition. Turnout was low, Labour gained less than 10 mn votes, representing 34% of votes cast, as compared with 2017 when under Mr Corbyn they amassed 13 mn votes, a 40% vote share. The two parties’ policies on taxation, defence, education, health, fintech and banking are virtually indistinguishable.

Despite so many common policies, many right of centre analysts were doom mongering before the election. Barry Norris of Argonaut Capital Partners: “Labour’s economic plans threaten to bankrupt Britain …undoing the Industrial Revolution…”³. Norris focused on net zero – where the two parties most strongly diverge. The new government has pledged that the grid will be 100% renewable by 2030, whereas their predecessors had cooled on decarbonisation and delayed previous transition deadlines.

The costs of the new government’s net zero acceleration are of course for consumers in the form of levies on their utility bills, but closer analysis shows an increased public debt burden of perhaps GBP 800 bn, equivalent to the entire official UK debt when the Conservative Party came to power in 2010⁴. The qualification “official” is inserted here because of course such official measures ignore guarantees and other contingent liabilities. The new UK government plans to game the definition of contingent liabilities by shifting direct public indebtedness into this box. It plans to introduce a new category of “strategic” as opposed to “day to day” direct public expenditure, and hope that financial markets and ratings agencies ignore strategic balances⁵.

Bizarrely, this might work. We have been here before; under the Tony Blair government in the late 1990s almost all new hospitals, roads, schools and other public buildings were financed under the UK’s unique version of public private partnerships. Labelled “Private Finance Initiative” (PFI), this financing model generated returns of 6-8% p.a. for senior lenders – whose risk exposure was essentially the UK government – at a time when government bond yields were 3-4% p.a. The accounting purpose was to have these facilities kept off the official public debt balance sheet, but the cost over the projects lives was much higher than had they been funded on balance sheet⁶. It is difficult to measure the exact impact on the markets at the time, but we suspect that markets largely played along and accepted the official metrics.

The UK financial markets have welcomed the new powerful Labour government, and are even calmer than markets in France and the rest of continental Europe⁷, so there is no reason for the new government to row back from its creative accounting plans for new “strategic” expenditure.

Conclusion

This expected wave of new UK green projects financed via creative accounting can be seen as piggy backing on the Invest EU model under the tutelage of the European Investment Bank Group⁸. Measures of annual deficits and debt to GDP have always ignored guarantees and contingent liabilities, so why worry about a little more creativity? Especially so if the purpose of the expenditure is to grow economies generating jobs and future taxes to service actual public debts. Financial markets are clearly happy with this, but less happy if either a party of the right had power and cut back on stimulus (as in the crushing after 49 days of the UK’s Liz Truss 2022 premiership) or if a party of the left looked likely to enact policies such as proclaimed by the NFP of France. Put differently, markets follow the narrative that the 2008 financial crisis is well behind us, that debts and deficits though large are under control provided that ‘extreme’ parties are kept at bay and prevented from disturbing the careful path to economic recoveries mapped out by sensible centrists and supported by their relevant independent central banks.

What does this mean for France as it faces the EU’s Excessive Deficit Procedure? We expect nothing much provided the NFP remains muzzled; perhaps an agreement on revised three-year public expenditure budgets showing ever so slightly slower increases in deficits. Financial markets will be delighted with such an outcome. What choice do they have? They can hardly abandon French debt and risk crashing the euro. In such a world, the actual public debt numbers don’t really matter anymore.