The much talked about European elections are approaching at a rapid pace which, to the surprise of many, is a good reason to unfasten your seatbelt, get up and make yourself a nice cappuccino. That’s right, the expected outcome of the European Parliamentary elections is expected to be negligible on EUR crosses (see chart) for reasons discussed below. However, it does carry a strong potential to move the needle on sterling.
First of all, the annual European Union fiscal budget is around €180 billion, which is roughly equal to the government budget of a small Eurozone country like Austria. From a fiscal perspective, elections in a country the size of Austria usually don’t offer much grounds to jolt EUR into motion, and neither will the election of a new EP do so. Even more so, because the EU doesn’t have the power to issue bonds to increase fiscal spending, which means there is virtually no room for the Eurozone economy to receive a boost from an extra spending round from Brussels.
The mechanism through which the EP elections could have an impact on the single currency is by telling us more about how much willingness there is among the European electorate for a further European integration, which for example could lead to more mature risk-sharing mechanisms in the Eurozone, from which fiscal soundness and the stability of the financial system will profit. In theory, this makes the euro more attractive as a more stable and versatile currency to hold, however, as this is such a long run game, the short term impacts on FX are likely akin to a butterfly flapping its wing. Also, the current centrist pro-European coalition is expected to remain its majority in the EP, which suggests a continuation of the status quo which won’t be shocking enough to move markets either.
The potential for the Great British Pound to be moved by the election result is higher, stemming from the same nationalism trend that can surprisingly work in favour, as well as against sterling’s prospects. British polls indicate that Nigel Farage’s Brexit Party is likely going to be larger than the traditional dominant forces in UK politics; Labour and the Conservative Party. An upside surprise to the strength of Farage’s fraction indicates a strong sentiment among the British voters towards a hard Brexit, which financial markets in the past have usually taken as a hint to reduce their sterling positions. A bit counterintuitive maybe, but a strong performance of continental nationalist parties can also be a pound positive story as this indicates these countries may be more willing to facilitate a lenient exit for the Britons. Such willingness to compromise from the continent can bring a more structured deal than the default hard Brexit closer, which can be a boon the British currency.
Chart 1: Option markets show no discernable increase in demand of protection against further EUR weakness, especially compared to previous political risk events. Neither so for sterling, though we argue markets may be a bit complacent in this regard.