Three scenarios after Europe's 'unexpected political shock'

It is still too early to know exactly how Europe's political landscape will change after the European election results. Is the Green Deal going to be watered down? Ecology has been heavily politicised in recent years and Green parties have lost influence so this is a possibility, says Benjamin Melman, CIO of Edmond de Rothschild Asset Management.

France, on the other hand, is now facing a much more uncertain period. Standard & Poor’s has just downgraded the country' credit rating on the grounds that extra growth from reform measures will not be enough to reduce deficits. The government recently cut spending by €10bn and is actively looking for €20bn in 2025. Without a parliamentary majority, the task was complicated. And now France is now suddenly being asked to vote at a time of economic and financial stress.

All elections are difficult to predict but three scenarios strike us as possible:

• Emmanuel Macron's Renaissance party more or less keeps its relative majority and the administration somehow trundles on. The party could try to form a wider governing coalition with other parties but no such arrangement has been reached before under this administration.
• The Rassemblement National (RN) obtains a relative majority. This would leave the country even harder to govern as opposition parties would find it easier to come together against a party which is seen as extreme. In these circumstances, someone from outside the political arena, or from another party, but with the support of the RN could be appointed as Prime Minister to broaden the consensus.
• The RN wins an absolute majority of seats.

The party’s economic programme will be unveiled in the next three weeks so we are still in the dark. Their latest complete programme was for the 2022 Presidential Election and costing by outside observers at the time suggested it would result in government finances worsening significantly, a worrying prospect given France’s current situation.

One might object that Georgia Meloni’s very pro-active 2022 programme also triggered serious debt crisis concerns and they proved unfounded. On the other hand, UK Prime Minister Liz Truss in similar circumstances suffered the consequences. And Italy’s government deficit was running at a hefty 7.2% of GDP in 2023 which is why the country is still being closely watched by rating agencies and investors.

And it might also be true that what international investors accept from Italy alone might not be acceptable for both Italy and France together should Paris opt to let deficits widen.

It is therefore tricky to speculate on French and European momentum in the coming weeks. So far, market reactions have been moderate. French OAT spreads with the German Bund have widened by 6bp and the US dollar and Swiss franc are up 0,5% against the euro. Pending better visibility, we would not be surprised to see a European risk premium returning. We are currently analysing our asset allocation.

By Benjamin Melman, CIO of Edmond de Rothschild Asset Management