Viewpoint: The first round of the Presidential elections in France could trigger a further correction

Apr 20, 2012

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The G-20 may bring some developments, but no final decision, on fresh IMF resources to ringfence the euro area crisis…..

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The stability programmes will provide indications on the health of public finances in the medium term. Market tensions are set to linger, as they are tied in part to the waning effects of the 36-month LTROs and to the uncertainty over the reactivation of the SMP, which for the time being remain the sole fast intervention tool. The first round of the Presidential elections in France could trigger a further correction, should Hollande win greater consensus than indicated by recent voting intention polls.

After a turbulent start to the week, tensions on the European bond markets eased somewhat, probably thanks to the outcome of the Spanish 10Y bond auction, at which demand was 2.42 times the offer, although yields were up compared to the previous auction. In general, news flows on the crisis are still far from encouraging. The Governor of the Bank of Spain confirmed the risk weighing on achievement of the 2012 deficit target, given the fragile macroeconomic picture and rather optimistic assumptions on revenue and spending. In Italy, the Council of Ministers has approved the Economy and Finance Document for 2012. Although the full text has not been released yet, the government announced downwards revisions to growth estimates (from -0.4% to -1.2% this year, and from 0.3% to 0.5% next year) and that it has postponed by one year (to 2014) balanced budget target (from an estimated -0.5% in 2013).

The revision of 2012-2013 targets is not entirely due to the adverse economic cycle (given the new GDP assumptions, based on the elasticity of the Commissions’ estimates, the deficit would level off at -0.8% this year and -0.2% next year). The government indicates that debt could reach 120.3% of GDP net of direct loans to Greece and of the share paid into the EFSF and to the ESM, (although based on our calculations, the aforementioned items should have an impact of around 3% of GDP). In our view, the new growth estimates are still slightly optimistic (our central scenario points to a -1.5% contraction in GDP this year, and a zero rate next year) and therefore we believe the deficit will level off at -0.6% in 201, with overall debt peaking at 123.3% of GDP this year. Market tensions may increase if the first round of the presidential elections in France see the socialist candidate Hollande achieve a stronger advantage than predicted by latest polls, based on which he is ahead of Sarkozy with 29% of voting intentions (vs. 24%).

The same polls point to Hollande as the winner of the second round on 6 May (58% vs. 42%). The possibility of Hollande coming out on top is a source of concern, given his opposition to the fiscal compact and his “revolutionary” proposal of bringing retirement age back to 60 years. To date, the markets have been relatively positive on France, but in the postelection period the government will have to adopt new measures to guarantee that the deficit/GDP ratio is brought back to 3% in 2013, and assure medium-term sustainability. This week the Netherlands too have come under scrutiny, as Fitch has warned it may lose its triple-A rating, and therefore its core country status, unless austerity measures are implemented. Some detail of the fiscal consolidation programmes in the medium term will become available in midweek, with the publication of the stability programmes.

The G-20 should bring some news on the enhancement of the IMF resources to counteract the euro area crisis to 400 billion euros, based on Mrs. Lagarde’s indications. EU countries have committed 200 billion euros; Japan 60 billion euros; Sweden, Norway, and Denmark 26 billion.

Australia said it is ready to step up its share. However, fiscal plans and G20 developments will not be enough to calm market tensions. Concerns remain on the capacity to absorb government refinancing flows and/or bank recapitalisation problems should the SMP remain dormant. If volatility increases, we do not rule out an ECB intervention. Despite opposition within the Council, the SMP remains the sole tool that can be promptly activated. Precautionary programmes and/or conditional loans imply longer timelines.

Appendix

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