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The author is Head of Policy Research at Algebris Investments.
Does the success of far-right politics threaten Europe's economy and its attractiveness to international investors?
With Marine Le Pen's far-right National Rally party winning a landslide victory in the European Parliament elections, French President Emmanuel Macron calling a surprise general election, and shocking news of an unlikely alliance between France's left-wing parties, this is the question investors seem to be asking.
In the week after the election, the CAC 40 index fell for the first time in two years, erasing most of this year's gains, while bond yields soared. The gap between French and German bond yields widened to levels not seen in seven years, while France's finance minister warned that the country was heading for a financial crisis.
It would be extreme to conclude that France is on the brink of economic collapse, and a mistake to assume severe repercussions across the continent, but there are risks at both national and EU level that could have long-term implications for companies and markets.
France experienced a knee-jerk reaction. Immediately after the unexpected political decision, investors switched to risk aversion mode while they digested the impact. However, a strong left-wing result in the elections would probably lead to more selling of French assets. Both the far-right and the far-left policy platforms call for the rollback of Macron's reforms and contain populist promises that are difficult to reconcile with EU fiscal rules. A stronger left would also signal a particularly worrying shift towards anti-business and anti-growth Euroscepticism. This is where the real risk for France lies.
Following the results of the European elections, many have compared Italy to France under Prime Minister Giorgia Meloni, arguing that her right-wing party has had less of a negative impact on Italian businesses and the economy. But this is not the most apt comparison.
The situation is similar to that in Italy in 2018, when two populist parties formed an unexpected coalition government in the elections. That government, held together by a mutual loathing for the EU, collapsed after just a year, but lasted long enough to get into a spat with the European Commission over the national budget, leading to rising spreads on Italian government debt.
Financial markets can effectively act as judge, jury and executioner for governments with reckless spending plans, putting the brakes on them. Prime Minister Liz Truss's Britain is another good example, and market movements over the past week suggest that investors are beginning to price in the risk of a similar scenario playing out in France.
At EU level, the risk of a weakened eurosceptic France is exacerbated by a weak Germany: Chancellor Olaf Scholz's disastrous election result will leave the German government weaker at home and in Europe for the rest of his term. This could cause the “French-German engine” of strong integration to lose momentum, leaving more room for the agenda-setting right.
Although the right has abandoned its demand for Brexit, it thinks differently about Europe. Polls across Europe show that climate policy is not a priority for right-wing voters who favor a strong defense focus. An emboldened European right could use amendments to the Green Deal to postpone or soften some provisions. Aside from the obvious negative consequences for the planet, this could make Europe less attractive as a destination for green investments.
From an investor perspective, the main issues to watch in the near term will be the next EU budget, including the carryover of the EU's “Next Generation” spending plan, and the fight over the EU's own resources. Given this uncertainty, global investors may be reluctant to take on European risk.
In a recent speech, Macron warned that Europe is mortal and its survival depends on our choices. So far, his choices have put pressure on France. While I don't think the rise of populism necessarily poses a fatal economic threat to the EU or France, history shows that populism can lead to instability and discourage investment.
The risks for Europe are more subtle. The European elections have revived the narrative of a divided Europe, where socio-economic views are shifting in opposition to the EU's stated policy priorities. The choices Europe makes to reconcile these deep divisions and address the root causes of the success of the far-right will truly shape Europe's future.
