Europe's political mayday

As French and Greek national elections approach, investors fear the success of Greece's anti-austerity parties and a change of French government will doom Europe to increased political and financial instability.

Markets have learnt the hard way that politicians are quick to jettison painful reforms when it comes to saving their own jobs. That’s why European investors are becoming increasingly anxious about May 6 – a day when both French and Greek voters head to the polls.

In Athens, of course, the fear is that the elections will turn out to be a major public revolt against Greece’s two major political parties that supported the deeply unpopular bailout program – the conservative New Democracy and the Socialist, or Pasok Party.

These two parties have seen their support slump as voters blame them for painful austerity measures. Indeed, at this stage it appears that the two main parties might struggle to cobble together a majority in the new parliament. There is a growing risk that the increasing popularity of anti-austerity parties – ranging from old-style Soviet communists to anti-immigrant neo-Nazis – will doom Greece to growing political instability and make it even harder for the debt-laden country to introduce the stringent austerity measures it promised in exchange for its latest bailout.

At the same time, investors are becoming increasingly worried about the outcome of the French presidential elections. Although French President Nicolas Sarkozy has been gaining ground, the latest opinion polls still suggest that his Socialist rival, Franois Hollande, will win the second round of the presidential elections, due to be held on May 6.

Investors are somewhat apprehensive about the prospect of a Hollande victory. In the first place, they worry whether Hollande will be able to enjoy the same sort of close working relationship with German Chancellor Angela Merkel that Sarkozy built up. These fears were fanned after Hollande promise to renegotiate Berlin’s beloved fiscal pact, which forces eurozone countries to commit to reducing their deficits and debts. Hollande wants the fiscal pact to put a greater emphasis on promoting European growth.

Even worse, Hollande’s commanding position in the polls is forcing Sarkozy to adopt an increasingly populist stance. At a campaign rally in Paris on Sunday, Sarkozy promised that if he won May’s presidential election he would push for the European Central Bank to actively support economic growth.

"If the ECB doesn’t support growth, we won’t have enough growth”, he said. "Europe must clear its debts, it doesn’t have a choice. But between deflation and growth, it has no more choice. If Europe chooses deflation, it will disappear; you have to remember the 1930s.”

Investors were alarmed that Sarkozy’s comments breached the agreement he reached with German Chancellor Angela Merkel last November not to discuss the European Central Bank in public. That agreement cleared the way for the ECB to quietly adopt more unorthodox measures to save the eurozone, including flooding the region’s banks with more than €1 trillion ($US1.31 trillion) in cheap loans.

The comments also drew attention to the long-running disagreement between Paris and Berlin over the role of the ECB. Paris believes that the ECB should be actively buying up the debt of countries such as Spain and Italy, in order to push bond yields lower. In contrast, Germany is nervous about the ECB’s already large exposure to risky Greek, Irish and Portuguese bonds.

At a time when fears about Spain are rising, the last thing investors want to see is a public stoush between Paris and Berlin over the role of the ECB.

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