What do European elections mean for Europe and financial markets?

Summary:

• EPP and S&D coalition is projected to lose a majority after elections this month
• Performance of Eurosceptic parties may affect financial markets as well as European economies
• A new European Parliament will consist of a lowered number of seats
• EURUSD, GBPUSD and DE30 among top markets to watch

The elections in the European Parliament start today and will last until Sunday. The outcome will offer a glimpse regarding support for far-right Eurosceptic parties and therefore may affect the outlook for European economies as well as some financial markets. Here is a brief guide what to expect:

Less seats in a new parliament

During the next 5-year term, the European Parliament will have 705 seats compared to 751 seats if the UK leaves the EU. Until then, the EP will still consist of 751 seats. The possible reduction is a result of Brexit and a different distribution of UK MPs. The UK holds 73 seats in the current configuration. 27 out of 73 seats will be allocated across 14 countries, hence the effective reduction of seats will be equal to 46 seats. In practice, this change will have a negligible impact on the future parliament.

Coalition likely to lose majority

Polls carried out so far this year suggest the current EPP/S&D coalition will lose a majority. Source: Wikipedia, XTB Research

The European Parliament is already in the hands of two major parties - the European People’s Party (EPP) and Socialists & Democrats (S&D) having 54% of seats. The Alliance of Liberals and Democrats for Europe (ALDE) is also in the ruling bloc. Nevertheless, polls conducted so far this year signal (on average) that the EPP/S&D coalition will lose a majority and could be reduced to approximately 44% of seats. At the same time, the largest winner is to be Europe of Nations and Freedom (ENF), the anti-immigration, hard Eurosceptic and far-right party. Although the ENF is projected to substantially improve its last elections’ result, the entire bloc of Eurosceptic parties is forecast to gain traction only marginally (their share in the European Parliament could increase to 28% from 27%, based on the polls). Last but not least, turnout in elections to the EP tends to be low (slightly above 40% in recent times), thus caution needs to be applied when analysing the mentioned polls.

Difficulties in forming new European Commission

Taking into consideration that the current coalition will be unable to form a new European Commission (a new EP could be more fragmented), there is the likelihood that it will not be fully created by the year-end. If so, it could mean more uncertainty for the European economy and for financial markets as well. From an economic point of view, the EC is very important body as it is accountable for European funds allocation.

The most eurosceptic parties

A recent rise in nationalism in Europe (far-right parties in many countries saw an impressive increase in support) has sown a grain of uncertainty when it comes to the future of many European economies. The elections to the EP will give another insight into this picture and show if these parties keep their support. Moreover, the European elections could be seen as a proxy ahead of local elections. Below we present a list of the most Eurosceptic parties by country whose outcome may matter when local elections are held:

• France - National Rally

• Italy - The League

• Germany - Alternative for Germany

• Spain - Vox

• Austria - Freedom Party

• Sweden - Sweden Democrats

• Hungary - Fidesz, Jobbik

Impact on markets

One needs to notice that a risk premium ahead of the elections remains quite low (excluding the Italy/Germany 10Y yield spread being fairly high due to internal reasons in Italy), hence there is a possible chance for markets to be surprised if, for instance, support for Eurosceptic parties proves higher than expected. On top of that, the fact that European stock markets are trading at quite demanding levels also adds to a potential downside risk. On the other hand, the euro does not seem to be in a position to lose ground markedly in the aftermath of the elections as it is trading close to its 2-year low.

Glimpse at charts

The EURUSD has declined roughly 10% since April 2018. Taking into account recent economic developments in Europe there are not many reasons to expect sharp EUR appreciation. On the other hand, the US dollar seems to be expensive. 1.1120 is another key technical level to watch for. Source: xStation 5

The German stock market has gained more than 15% since the trough seen in December. This outcome has come despite difficulties in the industry sector in many European countries. The technical levels to watch are localised at 12 440 and 11 590 points respectively. Source: xStation 5

The British pound may also be the market affected by the elections. The GBPUSD has recently accelerated its downtrend due to another failure of T. May on the horizon. The crucial support to watch may be found at 1.2480. Source: xStation 5