A ‘no' vote in France and the Netherlands on the European Constitution, along with Britain's shelving of a referendum, is likely to see European bond spreads widen in the medium term and weaken the euro on the back of political instability, say fund houses.
Investment briefings issued by Axa Investment Managers and F&C suggest while there will be no significant affect on the European investment markets as a result of the recent ‘no’ votes on the constitution, political pressure regarding the future of the European Union (EU) will weaken the euro slightly and focus attention on the budget deficits of countries with high public debts.
In particular, analysts at Axa suggest the political upheaval could be “a source of instability and uncertainty”, which the markets will not like, while the lengths to which the euro will be weakened will depend on the number of countries which now reject ratification.
“As the ratification process continues, we can expect the bond markets to be more volatile. It is also possible that spreads will widen within the eurozone, particularly for countries with high public debt and deficit levels, such as Italy, Greece and Portugal. Indeed, non-ratification could create doubt about the budgetary discipline of the eurozone nations,” says Axa.
“For many of the newest members of the Union – such as Cyprus and Malta – which have not yet joined the eurozone, spreads should also widen as the markets pay increasing attention to Maastricht criteria when shopping for government bonds, suggests Axa.
Whereas bond markets could be impacted by concerns about individual countries’ ability to keep debts under control, Axa says equity markets are unlikely to be affected, although in the short-term investors may be wary of the French market, given the political importance Chirac places on the EU.
Steven Andrew, economist at F&C, however, has instead focussed his attention on the euro as he argues while the euro is likely to stay within the Euro1.20-1.30 range over the next year, instability could increase as it may force the EU to assess what might happen if some countries pull out.
“A more esoteric upshot of the Constitution’s rejection is that it raises questions over the sustainability of the entire European project. The fact that two of the founding members of the EU have rejected a key element of the Union’s platform for the future – coinciding with the broader examination of the extent to which some member states’ efforts to boost competitiveness are restricted by staying in a currency union – may be enough to encourage the financial community to conduct a cost-benefit analysis for certain countries of staying in or getting out," says Andrew.
“In reality, we would ascribe no more than a 5% probability to any nation leaving EMU in the next decade, but for markets not even used to examining the notion of a break-up this is likely to mean a periodic increase in risk premia especially for the peripheral markets,” he adds.
When the Netherlands last week said no, the euro fell to its lowest level against the dollar since October, dropping to Euro1.22 compared with an average Euro1.24 last year.
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