Eurozone anxious over Europe's 'election of the year'

THE most important national election of the year in Europe is held on Sunday as Spain goes to the polls for the third time in as many years. With no single party expected to win nearly enough votes for an outright majority, either another period of minority government or a potentially shaky coalition will add to political uncertainty in the eurozone's fourth largest economy.

According to latest polls, the ruling party of Socialist Prime Minister Pedro Sánchez is likely to win the most seats. Yet, with only around 30 per cent of voter intentions, the Socialists (PSOE) could fall some 50 seats short of the 176 seats needed to win a majority.

Barring a continued period of minority government, this would open up the need for a coalition. Here many voters favour a tie-up between PSOE, the leftist Unidas Podemos and nationalist Basque and/or Catalan parties.

Given the significant uncertainty over the election result, markets are worried about potential further uncertainty that come after Sunday. In part, this is because of mounting signs of political instability across Europe - which will be reflected in next month's European Parliament elections where anti-integrationists are anticipated to make gains - plus stagnating growth in large eurozone economies like Germany, France and Italy.

Indeed, the single currency area may be on the brink of yet another downturn with European Central Bank president Mario Draghi warning this month that current economic indicators are "weak". And this even before the possibility later this year of a no-deal Brexit which could be a significant economic shock across the continent.

Sunday's Spanish election comes after Mr Sánchez was sworn in last June as the nation's prime minister. And the political instability in the country is mirrored in France, where President Emmanuel Macron remains under pressure from so-called 'yellow vest' protests which have now occurred 23 weekends in succession, and Germany where Chancellor Angela Merkel's long period in power is in its twilight.

Meanwhile, in Italy, Prime Minister Giuseppe Conte felt forced last weekend to say that his government will survive beyond May after speculation that clashes within the ruling populist coalition could prompt snap elections. This follows disagreements - including between the two deputy prime ministers Matteo Salvini from the far-right League party, and Luigi Di Maio from Five Star - on issues from migration, security, and transport.

POLITICAL ANGST

Moreover, this political angst, alongside the continuing drama of Brexit, appears to be contributing towards flagging European economic growth. On April 18, for instance, the IHS Market composite purchasing managers index - a measure of activity in the manufacturing and services sectors - fell to a three-month low. And this after the counterpart IHS Market measure for the manufacturing sector, alone, fell to the lowest level on April 1 for six years.

While Germany narrowly skirted a technical recession at the end of last year, the Italian economy is in what has been called a 'perma-recession' in a blow to the populist, right-wing government which has promised to rejuvenate the economy. Mr Conte said at the weekend that the government will soon approve a "growth decree" with a set of pro-economy measures, and ruled out any increases to the value-added tax.

It is in this context that the latest Spanish political uncertainty comes with key concerns over the nation's future governance. This is because the PSOE, which remains most likely to lead the next government, is nonetheless still widely blamed for the fact that it was also in power around a decade ago when the economy went into deep recession, and at the last election in 2016 suffered its worst national election showing since Spain transitioned to democracy after the 1975 death of dictator Francisco Franco.

This setback for PSOE comes in the context of an even bigger story in Spanish politics following the June 2016 election which saw no party emerge with an overall majority. A dominant narrative of that ballot, the second in the space of six months, was the shattering of the long-running post-Franco political duopoly of the right-of-centre People's Party (PP) and PSOE that has dominated the country since the late 1970s.

Several 'new' parties have helped fill the political vacuum. This includes a new far right nationalist party Vox which could secure parliamentary seats for the first time on Sunday. Other recent new parties include the leftist Podemos and Izquierda Unida (collectively known as Unidos Podemos which is seen as the sister grouping of the ruling Syriza in Greece), and the centrist, business-friendly Ciudadano. The rise of these groups has been fuelled by popular anger over political scandals, and the previous fallout from the worst recession in the country for over a generation which saw a property crash, and unemployment peaking at 27 per cent.

While PSOE looks likely to emerge as the largest party on Sunday, depending upon the exact election results, it is possible that an anti-Socialist alliance could also emerge. This would probably be between PP, Ciudadanos, and Vox, although it remains unclear if collectively these three will win the threshold of 176 seats.

In this context, and amid the growing political clamour for independence in Catalonia, a key backdrop for Sunday's election is the tension between Madrid and separatists in Catalonia over the enduring territorial and political crisis. Separatist tensions reached a spike in 2017 when Catalonia sought to break away from Spain in a referendum.

On this issue, Mr Sánchez is walking a political tightrope between his potential need for support from Catalan parties post-election, and a countervailing requirement to not appear 'soft' on independence which is opposed by many in Spain. To this end, he said earlier this month that he will act with "strength and proportion" against any attempt by nationalists to repeat the 2017 separation bid.

INSTABILITY

In this big picture of political uncertainty, financial markets may become increasingly jittery if the election outcome does not provide even short-term, let alone medium-term stability. If political risks were to rise significantly, this would have the potential to undermine the Spanish economic recovery.

Taken overall, Spanish governmental uncertainty is a microcosm of wider political angst within the eurozone, including in other large economies of Italy, France and Germany. This instability across these eurozone nations may yet help drive the single currency area into a new slump, especially if the shock of a no-deal Brexit adds to the continent's current woes in coming months.