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December 21, 2018

Not just Brexit makes 2019 a year of EU uncertainty

This is the last briefing before the holidays. We wish our readers merry Christmas and a happy New Year. We will resume on Friday, January 4.

We would like to focus in our last briefing on what we consider one of the most important issues for 2019 - the uncertainty surrounding the political fates of Angela Merkel and Emmanuel Macron.

Merkel, thanks to her office but also to her personality, has played for many years such a quietly decisive role in the European Council that more than a few policy actors find it hard to imagine how things might turn out if the grand coalition in Germany were to fall apart and Merkel to step down as Chancellor. A complicating factor is that there are many who find it difficult to make out who Annegret Kramp-Karrenbauer is. Her conservative position on an issue like gay marriage has been widely reported, creating confusion in people’s minds as to how much of a centrist she really is. This has given rise to fears that the CDU, once Merkel is no longer Chancellor, might become less 'European', and to concerns that Germany will no longer be as reliable as the ultimate political guarantor of the EU.

We believe that these fears have no basis in reality. But that they exist is revealing. Merkel’s policies have at times led to considerable strains within the EU but, at the end of the day, her peers saw the German chancellor as one of the most dependable factors in the upper stratum of European politics. The prospect of her possible departure in 2019 creates a feeling of deep unease.

With Macron, the unease is different but generates just as much anxiety. Will he be able to pursue his reform agenda? Will the French economy respond to it with better growth? Is it his re-election in 2022 still virtually a given? If Macron is seen to fail to regain control of events after his annus horribilis in 2018 — first the embarrassing Benalla affair involving his bodyguard, then the gilets jaunes storm — could Marine Le Pen, Jean-Luc Mélenchon, or someone like them make it to the Elysée?

The Franco-German couple is often criticised for its dominance in EU affairs. Now, there are fears that both partners might each become so self-involved that they might fail to provide enough joint leadership. Mark Rutte has spotted that Brexit on the one hand, and Merkel and Macron’s diminished stature on the other, might offer an opportunity. During the EU summit last week Donald Tusk, Jean-Claude Juncker, Macron, Merkel and Rutte discussed how to handle the Brexit problem. That Rutte joined the ‘big four’, turning the group into a ‘big five’, elicited no enthusiasm in the Italian, Polish or Spanish delegation. The impression was confirmed that The Hague seems to be trying try to turn Brexit into a Dutch power grab.

For the Franco-German relationship, too, 2019 will be a period of uncertainty. Macron cannot be sure that Merkel will be in office in a year's time. Merkel cannot be sure that Macron will not prematurely decay politically into a dangerously-lame duck. Merkel’s almost fulsome praise for Macron during the recent European summit shows that Berlin has understood how potentially perilous for Germany and Europe Macron’s more fragile position is. But with a big series of local and regional elections in Germany after the European one in May, and with the CDU trying to halt and reverse its own decline under a new leader, Macron cannot at this stage count on more than verbal support from his German partner.

It is true that Berlin has woken up from its Macron-induced complacency regarding the political landscape in France. That Berlin’s answer to Macron’s European reform drive was so lukewarm had a lot do to with the feeling that, with Macron’s re-election assured in any case, there was no need to make any special effort to help out the French president. But we believe it would take a stark rise in the polls for Le Pen, Mélenchon, or a similar figure to shock Germany next year into sacrificing some of its own short-term interests or orthodoxies and hand Macron a European win.

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December 21, 2018

Sentiment is fickle, especially about sentiment

We would like to end the year with an observation that opinion about the economic outlook is fickle. Just like in the financial market there is often an outsized reaction to the latest piece of data. This is to say that there is virtue in keeping a steady hand like the ECB has been doing, though a building consensus that an economic slowdown is coming may have contributed to the strong reaction in the stock market to the Fed's latest rate raise of the year. This also illustrates herd behaviour. Because of the slowdown consensus the market was expecting a more dovish stand from the Fed, but now the resulting sell-off is being used as further evidence to point to the coming weakening of the economy. There is a certain circularity in all this.

Another case in point is a story from Handelsblatt celebrating the strong cyclical position of the German economy, which would explain a €45bn yoy reduction in German public sector debt outstanding, and the German public debt ratio falling below the Maastricht limit of 60%. This appeal to the good moment of the German economic cycle is odd when just a month ago the latest quarterly growth figure was -0.2% for Germany. In fact the debt reduction was budgeted by the German government, so the question of whether the economic cycle has helped or not would have to be addressed by looking at whether tax revenues were higher than budgeted, not higher than a year ago. The indications for the German economy are that consumer demand is strong, but that production in the car industry is still lagging due to the stoppage in the summer over emissions certification of new vehicles. Nevertheless, the DIW institute expects the German economy to return to growth in the fourth quarter and says that recession fears are overstated.  

We have noted that the slowdown in eurozone GDP growth this year and especially in the third quarter correlates with a slowdown of exports, while domestic demand growth holds up including fixed capital investment, a critical driver of growth. Changes in inventories are, however, contributing to growth which may be a result of exporters accumulating unsold stock rather than curtailing production. PMI is in, and though it continues to weaken it's still above 50% which does not point to a recession. 

Overall, therefore, we would have to agree that the risk of an impending cyclical recession is overblown. But the eurozone economy is vulnerable to exports weakening, which could come from political shocks such as Brexit or Trump's tariffs, as Wolgang Münchau noted in his latest FT column.

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December 21, 2018

Father Christmas - French edition

Who is next? The gilets jaunes got their Christmas package from Emmanuel Macron, a gift that was confirmed by parliament yesterday. It did not cover their complete wish list but a €10bn boost to households' purchasing power is certainly a substantial present from an otherwise uncompromising president. Then there is the police force. After their strike action on Wednesday they got a €40 net increase per month, which translates into a €70m spending rise in total. 

More claims emerged from the public sector based on the argument that they do not benefit enough from the purchasing power measures. The government wants the Christmas gifts period to be over. Macron tempered expectations saying that not all grievances can be solved with a magic wand. Meanwhile the budget minister insisted that the state - appearances notwithstanding - is not Father Christmas. 

A meeting with the civil servants yesterday though confirmed that there are more claims to come. The government tried to take the wind out of further demands from the civil service by giving assurances that some of the measures - the de-taxation of the overtime pay or the in-work subsidy - will benefit the public sector too. Also, the wage agreement in place for the period 2016-2021 already foresees a substantial rise of €745m in 2019 after a freeze this year. But the trade unions seem to be unimpressed and already look at possible dates for their strike actions. The justice ministry has one planned for January 15, and another is in preparation for nursing homes. And this with the public sector reform on the horizon. 

Europe had hoped that Macron would be another Schroeder but now he looks more like Renzi, is what some are already saying. If Macron cannot regain momentum, his presidency will turn into a nightmare with more conflicts, concessions, higher deficits and a loss of capacity to reform. 

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December 21, 2018

King suspends Michel's resignation

If you want to see how a country manages to make sense of the absurd, or puts the absurd to work in the service of common sense, come to Belgium. Given that government crises are almost as frequent there as rainy days, the Constitution and constitutional praxis offer a wide array of possibilities to circumvent the obvious, play for time and avoid a real political crisis. We reported on Wednesday that Charles Michel had resigned following the collapse of the government coalition. King Philippe, having received Michel, decided to 'suspend' the resignation, the Palace announced. The idea is to see whether a solution can be found that avoids early elections. Normally, elections would happen in May, on the same day as the European elections.

The King, following the usual custom in such crises, scheduled meetings with Belgium’s main party leaders. This time, the aim was to sound them out as to whether they would be agreeable to Michel remaining in office until May, heading a caretaker government. It looks like this might be successful, the newspaper DH.be reports. One main reason is that most of Belgium’s political parties are keen to avoid the cost of having to run two electoral campaigns in rapid succession.

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December 21, 2018

EP has objections to the withdrawal treaty

As if the Brexit process was not complicated enough already, a potential new obstacle has arisen. Earlier this month Antonio Tajani, the EP president, wrote a letter to Sebastian Kurz, the Austrian chancellor who holds the rotating EU presidency. According to Der Spiegel, Tajani wrote that the total exclusion of the European Parliament from the post-Brexit environment was unacceptable. Parliamentary leaders have threatened to veto the agreement unless their specific concerns are addressed.

A word of warning. The letter dates back to December 7, and its content may have been superseded by events. Threats such as these stake out negotiating positions. They might be quietly neutralised in other ways, or more directly through side letters that set out additional clarifications. The offending bit for the EP is the joint committee to settles disputes between the EU and the UK after Brexit. The parliament has no formal involvement in it.

It will be interesting to see how the EP's insurrection interacts with the parallel attempt by the British government to seek additional clarification on the backstop. While the European Parliament has different priorities, both sides have in common that they do not wish the transitional period to become permanent. 

In the UK, a cross-party group of MPs added an amendment to the finance bill that would make it impossible for the government to set aside funding for no-deal Brexit preparations. The false notion that parliament can somehow block a no-deal Brexit through an amendment remains prevalent even among MPs, and is readily and uncritically reported. One other interesting detail is a much-noted change in the official wording of government documents setting out the no-deal preparations. The previous reference to the "unlikely event of no-deal" has been dropped. No deal is turning into a real option.

Nobody is in a position to forecast how this will end, but we would hope - and expect - that as we get close to decision time MPs begin to accept at the very least the pertinent legal facts of the situation: that no-deal Brexit is the default, and that both the deal and second referendum/revocation options require legislation. It is hard to envisage that being done without the support of a government.

A vote is due to be taken during the week of January 14. The final date has not been set as the negotiations with Brussels still continue. A 'no' vote would trigger the full deployment of the no-deal programme, both in the UK and the EU. At that point, the options branch out wildly. 

We see no point in attaching probabilities to options - as such numbers are usually drawn out of thin air. But we can rank them. The most probable outcome in our view is still a deal, followed narrowly by no-deal, followed by no-Brexit. 

We note a different ranking by the legal journalist David Allen Green, who says the law of least resistance would suggest a different ranking: no deal, deal, no Brexit. 

While this ranking is different, they have one thing in common - that this is most likely a choice between the deal and the no-deal alternatives.

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December 21, 2018

Let's break the law

The EU-wide agreement on new CO2 emissions limits is a sign that the lobbying power of the car industry is waning. That agreement would not have been possible even five years ago. Environmental Action Germany, one of the main environmental groups, is now focusing on its next big target - the introduction of a motorway speed limit. Considering that the next coalition in Berlin will invariably include the Green Party, a speed limit stands a good chance of being introduced early in the next decade. This will have a huge impact on the sales of cars with high-powered engines - as it will remove the last public space on Earth where their power can be utilised in full. 

We also noted an article in FAZ discussing a car industry expert's strategic advice. His conclusion is that the best way forward for the German car industry is to ignore the rules, and pay the penalties. We are surprised that FAZ reports this statement with a straight face. The advice assumes, implicitly, that such a strategy will continue to be viable in the future. Changes in German law, like class action suits, could make deliberate forms of cheating prohibitively expensive. The reasons that cheating strategies were viable in the past have been a legal system that favoured the industry, and a government that turned a blind eye. Our conclusion is very different: the only way for the EU to meet the agreed target is to increase the market share of China-made electric cars during the next decade.

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