The polls show a close finish for Leave and Remain in the UK referendum. The outcome is within the margin for error for polls on the latest figures, so market participants are carrying out plenty of short-term trades based on trying to guess the result. In a week when the UK is in the spotlight with the Brexit vote, we need to remember the impact on the rest of Europe.
German and French shares have been very volatile recently, with some ascribing their movements to the changing perceptions of the likely outcome of the UK vote. Over the past year European shares generally have performed badly. Over the past three months they have done a bit better.
It is true that if the UK leaves the EU there will be costs and difficulties for the other members. Voting arrangements have to be altered, the missing UK contributions to the budget replaced, and the European Parliament changed. However, dealing with the troublesome island partner is by no means the only or even the biggest problem the euro area faces.
While the UK has the luxury of a debate on whether to stay or go, those locked into the euro are daily seeking to buttress their weaker banks and agreeing how much extra money to create. They are agonising over the right balance between stiffer central controls over spending, tax and borrowing as the Germans wish, and allowing some latitude and debt relaxation to prevent a Greek crisis or banking problems emerging elsewhere. They are planning VAT reforms which centralise and reduce “distortions within the single market” from differential tax rates.
A general problem many European countries face is how to create national political stability. Electorates are becoming fractious over the euro scheme and the free movement of labour. Continental political systems that encourage proliferation of parties by offering proportional representation struggle to deliver strong and stable governments.
Disaffection and the relatively easy access for new movements afforded by PR systems encourages parties to spring up with distinctive or extreme agendas, and allows single topic campaign groups to gain seats on elected bodies. In the UK with first past the post voting this has been more difficult, with the Eurosceptic challenger party UKIP unable to get anyone directly elected to Parliament other than an MP already in the Commons who defected from another party despite having a substantial voting base.
This week we have seen the growing strength of Italy’s 5 Star movement. It captured the mayoralties of Rome and Turin with impressive popular votes. This movement wants a referendum on continued euro membership. It is in favour with the voters because it spurns large establishment political donations, is anti-corruption, only allows its representatives to serve two terms, and pays for elections through crowd funding. The two new mayors are both women, representing a breakthrough for female representation. As a party which scorns the cosy and sometimes corrupt ways of the two main parties in Italian politics, 5 Star is not willing to enter coalitions to shore up the precarious political structure.
The Italian Prime Minister’s response to the dwindling popularity of his party and the former main opposition party is to press for constitutional reform. He wants to replace a directly elected Senate with a Senate mainly of regional politicians and mayors. The new Senate would no longer have the power to bring a government down by a vote of no confidence. He wants to grant to the party which comes first in a general election extra seats in the Chamber of Deputies to help it form a stable government.
Greece trod this path in a desperate effort to save Pasok and New Democracy as governing parties, the Labour and Conservative equivalents there. Despite the grant of extra seats they were both still swept aside by Syriza when public dislike of the austerity policies common to both pro EU parties became too strong. The system of extra seats to save the traditional parties helped Syriza form a government.
In Spain they are also trying to get a better mandate for a new government by having another general election half a year after the one which failed to produce a winning party or coalition able to govern. Latest polls show the Spanish electorate still split between several choices, unlikely to result in any party winning a majority. The two traditional main parties languish on around 50 per cent of the vote combined, with Podemos and Cuidadanos, the two new challenger parties, doing well.
In Catalonia the nationalists also find plenty of supporters for their view that the richest part of Spain would be better off with self-government. Podemos, currently in second place in the polls, favours an independence referendum for Catalonia.
Markets will worry about the Spanish General election, the Italian referendum, and growing support for various anti-establishment parties around Europe. The share impact will flow from the uncertainties, and in the longer term from the policies which this tide of opinion seeks. It will be more hostile to large corporations, demanding they pay more tax, pay more to the lower paid, and show more restraint at the top.
There will be renewed drives to stop tax avoidance as well as evasion, and some concerted action across borders against large companies. When the Brexit vote is out of the way there will still be political risk. It’s just something markets always have to live with. We still think shares are better value than bonds, and expect interest rates to stay lower for longer to underpin current high valuations.
On the new Rome Mayor’s agenda is the wish to get the Papacy to pay its fair share of Roman taxes. This reminds us that no establishment institution is sacred enough to avoid challenge.
John Redwood is global investment strategist Charles Stanley