John Redwood: Risks to the break up of the Euro are receding

by John Redwood

The European economies are picking up. Survey evidence shows growing consumer and business confidence. Credit and money are growing at reasonable levels. The European Central Bank intends to keep rates negative for longer, and to carry on creating more cash to buy up euro area state debt.

The economic case for holding European shares has been growing in strength for some time, and buyers have emerged this year to take advantage of these conditions. The Spanish economy has been enjoying a decent recovery for some time.

The German economy remains very strong, with a huge trade surplus and good export figures. France is picking up a bit. Greece remains under pressure, and Italy is also finding it difficult to pick up speed. European shares are a bit cheaper than US ones.

Overhanging the markets has been the issue of political risk. Elections in the Netherlands and France this year have placed the future of the euro and the EU project on the ballot paper. As expected Mr Wilders with his anti EU stance emerged as the leader of the largest party in the Netherlands but is unlikely to have a role in government. The Parliament still has a large majority in favour of euro membership.

In France Marine Le Pen wishes to take France out of the euro and hold a referendum on EU membership, but she trails badly in the polls for the anticipated second round ballot run off against Mr Macron. In Germany the AFD challenge by a party hostile to the euro is being squeezed by a return of the more traditional rivalries between the CDU of Mrs Merkel and SPD under a strongly pro-European leader, Mr Schulz. Political risk in the sense of the possible election of governments wishing to break up the Euro is receding.

It is true there could be an election this year in Italy, where Mr Grillo is running well with his anti-euro 5 Star party. It is also the case that the Greek debt issues have not been resolved. The growing reluctance of the IMF to advance more money when Greece needs it to repay debts this summer is a problem for Germany who always insists on IMF participation. It is seems unlikely, however, that after all the money advanced to Greece and the drama over Greek debt Mrs Merkel would want to let Greece tumble out of the euro just before her election. It looks likely that the euro will once again survive its brush with mortality and emerge with all its members beyond the elections and debt repayment.

The formal notification of UK withdrawal from the EU poses a more real challenge to the institution. UK commentary seems to concentrate on the possible effects on the UK. It might be wiser to look more at the effects on the EU, as they are the ones receiving the budget contributions and running the large trade surplus. The EU will need to put together a seven year budget plan for the period after the UK’s departure without the substantial UK net cash contributions. They will have to decide whether to increase the bills of all the other members, or whether to cut back spending. It seems more likely they will seek to tax member states more. Germany and France along with some of the smaller richer countries will become larger net contributors. This may require modest tax rises in these countries.

Germany and the other large exporters will also need to consider their trade with the UK. If, as some in the EU argue, there have to be tariffs and other barriers to trade under WTO rules on UK exit, then there will be some damage to the continental economies. The main area where high tariffs will be experienced under the generally benign low tariff WTO regime is agriculture. The French wine and dairy industry, the Irish beef industry, the Dutch flowers and market garden industry and the Danish bacon industry amongst others might lose substantial exports. The UK might switch to a combination of more domestic production and cheaper products from non EU sources, where it could lower tariff barriers once out of the EU through WTO procedures.

All of this is containable. The agricultural sector does not have a big representation in share indices, and the impact on the total EU economy will not be large. There is always the chance that on reflection the EU decides the UK offer to continue with tariff free low barrier trade works for them as well.

John Redwood is Charles Stanley’s chief global strategist

Thursday, April 6, 2017