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European political risk in 2017 and the rise of populism

In June, UK voters opted to leave the European Union, prompting the resignation of Prime Minister David Cameron. Next, November saw Donald Trump emerge the surprise victor in the US presidential election.

The trifecta was completed in December by the anti-establishment ‘no’ vote in the Italian referendum.

None of the outcomes were predicted by the polls and all suggest a backlash against political correctness and a challenge to long-held establishment truisms.

The political surprises of 2016 have had a significant impact on interest rates, currencies, inflation and, potentially, economic growth. So, with voters showing themselves to be nativist, nationalist and protectionist, is there a chance that far right groups will triumph in some of the elections due in Europe in 2017? And what impact could this have on investors?

Italy

The referendum result is a boost for the insurgent M5S party, led by former comedian Beppe Grillo. However, the immediate consequence has been a continuation of the previous regime, but with new people in key positions. An early general election is now more likely although the Italian parliament has to pass a new electoral law before this can happen.

The current law gives a working majority to the largest party, but some parts of it have been ruled unconstitutional by the Italian supreme court. Some parties are hoping for a more proportional process that could prevent M5S from winning.

The Netherlands

A Dutch general election is due on 15 March. The current government is a coalition of the People’s Party for Freedom and Democracy (VVD), the Democrats (D66) and the Labour (PvdA) parties.

However, the right-wing, anti-Islamist, anti-immigration and anti-EU Party for Freedom (PVV), led by Geert Wilders, is tied for the lead in polls.

Saying that, on the basis of recent opinion polls, it would take at least four parties to form a stable Dutch coalition. What we’re likely to see is a long period of uncertainty as a new government is formed. However, this is normal in the Netherlands and should have little market impact.

France

Marine Le Pen winning the French presidential election in May 2017 would be the greatest shock in post-war European politics. A referendum on France’s EU membership would be likely to follow a victory for Le Pen’s National Front party.

Although France’s two-round runoff voting system makes Le Pen’s success unlikely, Trump’s US victory spelt the end of foregone electoral conclusions. In fact, some of France’s leading mainstream politicians have warned that the world’s next political earthquake could happen in France.

However, despite Le Pen’s popularity in the polls, history shows that when faced with a possible National Front victory, French voters prefer the other candidate – which in this case is Republican François Fillon.

Germany

Chancellor Merkel’s principled decision to open Germany’s borders to high numbers of refugees has made immigration a highly emotive issue.

The governing coalition of the Christian Democratic Union of Germany (CDU), Christian Social Union (CSU) and Social Democratic Party of Germany (SPD) has lost support to the right, giving ground to the Alternativ fur Deutschland (AfD).

Merkel will stand again for the CDU in the 2017 general election. But with the AfD now approaching 20% in national polls, there could be destabilisation and market nervousness ahead.

Conclusions

There was plenty of political upheaval in 2016 but 2017 could be the financial markets’ biggest test yet. The UK Government is set to trigger Article 50 before the end of March while the upcoming elections in France, Germany and the Netherlands could increase political discontent across the continent.

However, from an equity markets point of view events may conspire to produce surprises on the upside as well as the down. We may see much-needed structural reform in France, a continuation of the steady rudder provided by Germany and Italian bank recapitalisation. Not quite what the doomsayers predicted. There’s life in the continent’s old order yet.

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