Opposition to productivity reforms and budget compromises compound debt issues as the European Central Bank weighs monetary policy.

Political stresses are becoming more evident in different places across the continent, including in France and Spain. These stresses keep bubbling up, reflecting popular dissatisfaction with the status quo. As a result, nationalist, anti-immigrant, and populist parties have fared well in recent years throughout Europe. And the eurozone’s reform agenda and economic growth continue to struggle against the difficult political backdrop.

France faces another burst of Poujadism

In France, the government recently raised taxes on diesel and gasoline. A typical driver filling a 50-liter diesel tank every week would spend an extra 13 euros a month. This was the spark that lit a fire of protest, encouraged by social media with expressions of inchoate anger reminiscent of the Poujadist movement (the political philosophy and methods advocated in France during the 1950s by Pierre Poujade, who in 1954 founded a populist right-wing movement). The protests have inevitably become a challenge to the broad reform agenda of President Emmanuel Macron’s administration. Protesters insist the new “green” taxes illustrate that Macron is the president of the rich and does not speak for the working masses. They issued a list of demands, including lower fines for traffic violations and more efficient public spending. Macron’s government eventually agreed to suspend the fuel tax for a few months.

The demonstrations reveal weaknesses in the central government and the President’s political capital. This matters because there are changes to the pension and unemployment insurance system that are on the docket for 2019. These reforms will face some opposition. For many people, Macron embodies a set of reform possibilities and a counterweight to the free-form anger that inspires so much of the populist right. It would be disappointing to see these possibilities ruled out. Past reform efforts in France have frequently failed because of this Poujadist street opposition.

Far-right party succeeds in Spain

The success of the far-right party Vox in regional elections in Andalusia (southern Spain) has sent shock waves through the country’s political establishment. The nationalist party won 12 seats in the region’s local assembly after the vote, far exceeding a prediction that it would win only two or three seats. Prime Minister Pedro Sanchez’s Socialist party lost seats in what had traditionally been a major stronghold. VOX is a fairly standard right-wing European party, conservative on social issues, hard line on “law and order,” and opposed to large scale migration.

Eurozone's growth trends lower

The VOX party is opposed to autonomy for Spain’s regions and are hostile toward the European Union because of their stress on Spanish centralized sovereignty. This is nothing out of the ordinary, and VOX only gained a handful of seats in the regional assembly. It’s interesting, however, because it increases the difficulty of running a coalition at the federal level, where the Socialist-led government has to pass a budget and needs support from other parties. These parties can now see the weaker state of the government and the threat posed by VOX. It also shows how widespread these political stresses are across Europe.

Italy’s ongoing debt debacle

Italy’s economy contracted by 0.1% in the third quarter of 2018 as domestic demand declined. If the economy is shrinking, the debt dynamics facing the country are awful, and this is not lost on the politicians in Rome, government securities (BTPs), or the eurocrats in Brussels. The government continues to debate its deficit target for 2019. While Italy doesn’t seem to care much about eurozone rules, it does care about the markets and whether it can finance budget plans. The European Commission has indicated it expects to launch an excessive deficit procedure (EDP) against Italy. This could come fairly soon, and it signals displeasure. The move would only matter if the ratings agencies or the markets viewed it as important. High levels of debt, widening deficits, and sluggish growth are a toxic combination, and Italy urgently needs reforms to buoy potential growth.

The ECB’s dilemma amid growth woes

Economic data across the eurozone continued to slip since the summer. But we believe things are not as bad as they look given that some European confidence indicators are stabilizing. The gap between the sentiment indicators and the manufacturing purchasing managers index (PMI) was quite large, and how this divide closes will be important. Part of the problem is Italy; it’s such a large economy, and the economic contraction weighs on the area’s aggregates. Eurozone inflation, on the other hand, was slightly weaker than expected in October due to weakness in food prices. We forecast one further move by the ECB in the second half of 2019. However, our confidence in this is falling, and the chances are rising that this cycle will end without an ECB hike.

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