2017 third-quarter forecast

Jun 26, 2017 | 13:51 GMT

13 mins read

Europe

To the west of Eurasia lays Europe, a region predisposed to division. It is surrounded on nearly all sides by islands and peninsulas that make it difficult for Europe to cohere. The northern half of the continent, moreover, sits on a plain whose short, meandering rivers tend to empower countries without forcing them to work with others. The southern half is situated on more mountainous terrain that has historically impeded the creation of strong, unified economies. As a result, Europe is a continent riven by pockets of distinct cultures whose differences are all too often irreconcilable.

Europe is a continent riven by pockets of distinct cultures whose differences are all too often irreconcilable.
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section Highlights
  • EU leaders will discuss several proposals to reform the bloc this quarter, but their diverging views will limit room for concrete action.
  • The approval of France's labor reforms legislation will mark an early political victory for President Emmanuel Macron.
  • The elections in Germany in September will not pose an immediate threat to the eurozone because moderate forces will stay in power. Nevertheless, the country's next government will play a crucial role in determining the currency area's future.
  • Poland's relations with the European Union will remain tense, and Warsaw will look to the United States, as well as its neighbors in Central Europe, for political support.
  • The fragile British government will focus negotiations over the Brexit on three main topics this quarter: citizens' rights, the United Kingdom's contributions to the EU budget and the future of Northern Ireland's border with Ireland.
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European Disintegration

In the first half of the year, general elections kept moderate forces in power in key eurozone countries such as France and the Netherlands. Germany is poised to follow this pattern in the third quarter as it gears up for a national vote in September. EU leaders are relieved that Euroskeptic parties have not been gained enough traction to take over national governments and threaten the bloc's continuity. But several questions remain unanswered. The European Union's members have diverging ideas about what the bloc should look like in the future, though they all agree that it must be reformed. Meanwhile, anti-establishment sentiments — a byproduct of a decade of economic malaise — are still strong across the Continent and will continue to threaten for the European Union with each successive election. Votes in Italy and Austria over the next 12 months will leave the bloc's leaders and institutions little room for complacency.

A Big Summer for Germany and France

The German general election, scheduled for Sept. 24, will not disrupt the European Union. Unlike in France, where nationalist candidate Marine Le Pen had a real shot at winning the presidency, in Germany, the Euroskeptic forces are relatively weak and don't stand much of a chance of reaching power. Though voter exhaustion with the country's two mainstream parties could lead to greater support for smaller parties, the moderate forces will retain power after all the votes have been tallied. Consequently, the German elections will not generate an immediate threat to the European Union's continuity. They will, however, be important to its long-term future. The next government in Berlin will take charge of the single most influential political and economic power in the European Union and will face critical decisions that will shape the bloc's course.

Leading the race are Chancellor Angela Merkel's center-right Christian Democratic Union (CDU) and the center-left Social Democratic Party (SPD). The parties, currently partners in a coalition government, will try to distinguish themselves from the other on issues such as public spending and taxation in the months leading up to the election, complicating federal decision-making in the process. After the vote, the CDU and the SPD's first order of business will be to try to form coalitions with smaller like-minded parties such as the Free Democrats, the Greens and The Left. But if that doesn't work out, they could come together again to form another grand coalition. The far-right Alternative for Germany party will probably enter the German parliament, but it won't make it into the government because other political groups will exclude it from talks over prospective coalitions.

The German government's final composition — which could take weeks to decide — will be crucial for the future of the country and of the European Union as a whole. A center-right alliance at the helm in Berlin would probably be skeptical about implementing risk-sharing measures in the eurozone and cautious about heeding Southern Europe's requests for reform in the currency area. A center-left alliance, on the other hand, would probably entertain the kinds of changes countries such as France, Italy and Spain are calling for. These matters won't come to the fore until the fourth quarter of this year and the early part of 2018, though.

France, too, will have an eventful third quarter. Newly elected President Emmanuel Macron will face his first political battle in the next few months: amending the country's labor laws to make them more flexible. Macron and the Cabinet, led by Prime Minister Edouard Philippe, will invest significant political capital in the reforms, negotiating with unions, employers' associations and lawmakers to pass the measures. Despite the French government's desire to reach a consensus among all interested parties, it won't hesitate to use its comfortable majority in the National Assembly to push the reforms through. Macron, moreover, will try to take advantage of his current popularity and of the fragmentation among labor unions to advance his agenda. Some groups will probably protest, generating temporary disruptions in the French economy and perhaps swaying the government to soften aspects of the reforms. Nevertheless, the new labor legislation will likely pass, and Macron, in turn, will clinch the first victory of his presidency.

The European Union Looks Forward

As domestic politics heat up in France and Germany, the European Union's core members, along with states such as Italy and Spain and EU institutions, will look to the future. EU leaders typically choose the summertime, when national parliaments are in recess, to discuss their big ideas for institutional overhauls. And though the bloc's constituent heads of government will have much to say about how to change the European Union, they won't get much done. Most (if not all) of the proposals will stop at the rhetorical level. France and Germany will make gestures to prove that their alliance is strong and present joint proposals to reform the eurozone. But they won't implement anything. Their mutual interest in preserving their bilateral relations notwithstanding, Germany and France still have differing views on how to reform the eurozone. Furthermore, the government in Berlin will avoid making any significant decisions on the currency area before its general election in September. 

Upheaval in Southern Europe

Elections aren't something Italy has to worry about in the third quarter, since the country's main political parties failed to agree on a new electoral law in June. The parties, however, will keep preparing for a vote either late this year or early next year. Regardless of when the general elections take place, they will present a test for the eurozone. Euroskepticism is alive and well in Italy, which boasts the third-largest economy in the currency area. Heading into the (eventual) vote, the country's pro- and anti-EU forces are evenly matched in their popularity. The prospect of a Euroskeptic administration will do little to assuage fears in and beyond Italy about the health of its troubled banks and the sustainability of its high levels of sovereign debt. And in the meantime, the government in Rome will be weak.

In Spain, strife between the central government and the regional leadership in Catalonia will escalate during the third quarter. The Catalan government has promised to hold a referendum on the region's independence Oct. 1. But Madrid will not authorize the referendum and will threaten civil servants in Catalonia with legal action if they insist on moving toward secession. Spain's central government hopes that it can apply enough legal, political and economic pressure to stoke discord in the pro-independence camp, forcing it to rethink the referendum or to hold regional elections early. Should the Catalan government decide go through with the independence vote as planned, the Spanish Constitutional Court would declare it illegal, and Madrid would ask security forces to keep the referendum from taking place. Demonstrations in support of independence cannot be ruled out this quarter as the date of the proposed vote approaches, but Catalonia will not declare independence unilaterally before then.

Central Europe's Worries Mount

States in Central Europe will spend the third quarter in a kind of stalemate with EU institutions. Hungary and Poland will continue criticizing the European Union for domestic political gain, but they will stop short of doing anything that could threaten their membership in the bloc. The European Commission, similarly, is unlikely to suspend Poland's voting rights in the bloc, though the two will remain at loggerheads over the rule of law. Brussels understands that it can go only so far in pressuring dissenting member states; introducing sanctions against them, for instance, would only deepen the bloc's divides. Consequently, it will refrain from taking specific punitive action this quarter in its infringement proceedings against Hungary, the Czech Republic and Poland for their refusal to enforce an EU measure to distribute asylum seekers across the Continent.

Still, the Central European states have several causes for concern. For all their complaints about the European Union, countries such as Poland and Hungary have been worried about getting left behind since the bloc discussed a system that would enable different member countries to integrate at different speeds. The prospect of member states in Western Europe moving in their own direction without Central and Eastern Europe threatens to disrupt the Continent's economic, political and security situation. In addition, Poland is concerned that the United States will waver in its commitment to allies in the North Atlantic Treaty Organization under President Donald Trump's administration. Warsaw will stick with its current strategy throughout the third quarter, advocating for a strong NATO presence in the region, maintaining close ties with the United States and working with nearby countries. When Trump visits in early July to attend the Three Seas Summit, Poland will seize the opportunity to champion its strong alliance with the United States. During the meeting of Black Sea, Baltic Sea and Adriatic Sea nations, topics of discussion will include ways to increase security and infrastructure cooperation.

Talking Trade and Russia

Trade and investment will rank high on the European Union's foreign policy agenda this quarter. To cope with uncertainty over the U.S. government's policy priorities, the bloc is trying to diversify its economic relationships. EU officials will hold free trade negotiations in the coming months with prospective partners such as Japan and the Common Market of the South (Mercosur), while continuing their dialogue to increase investment ties with China. A recent ruling from the European Court of Justice will give the European Union a clearer picture of how to handle these proceedings in the future. The decision clarified which aspects of a free trade negotiation the European Commission can manage alone and which ones require a vote among the bloc's members. The agreement with Japan, which has already made significant headway, could reach its final stages during the third quarter. But the other negotiations underway will face more challenges, from disputes with Mercosur over agricultural exports to concerns among EU members about China's treatment of European investors.

At the same time, the German government will keep defending the importance of global trade and open markets. To help with this endeavor, Germany will look for as many allies as it can get and will use the upcoming G-20 summit in Hamburg in July as a forum to push the issue. Berlin, meanwhile, will continue to defend itself against accusations about its large trade surplus and work to persuade the U.S. administration to take a softer stance toward it.

Trade won't be the only topic of discussion among the European Union's members in the third quarter. On July 12, the bloc will hold a summit with the leaders of Albania, Bosnia and Herzegovina, Kosovo, Macedonia, Montenegro, and Serbia in an effort to preserve its influence in the Western Balkans and to keep the hope of EU accession alive there. The European Union will likely promise economic and political support for the governments of these countries and ask them to increase their regional cooperation, as well. Europe's interest in the area is part of a strategy to enhance its soft power to keep Russia's own foreign policy ambitions in check. In and beyond the Balkans, relations between Brussels and Moscow will remain tense throughout the third quarter. France's new government is ready to side with Germany to maintain a tough stance on Russia.

Trying to Make a Graceful Brexit

In the United Kingdom, domestic politics will bleed into the country's negotiations to leave the European Union. Prime Minister Theresa May's government is in a tenuous position after the Conservative Party's worse-than-expected electoral performance in general elections in June. The United Kingdom will not change its position on key issues, such as leaving the EU single market and trying to negotiate free trade agreements with multiple countries and blocs. But May's government will be negotiating from a position of relative weakness and won't have much leeway in the talks. The administration's very survival now depends on its alliance with the smaller Democratic Unionist Party (DUP). And because the DUP wants to ensure that Northern Ireland keeps its open border with Ireland, an EU member, after the Brexit, London will face greater pressure to make a deal with Brussels. May's administration may have to go back on its campaign promise that "no deal is better than a bad deal."

During the third quarter, Brussels and London will work to reach an agreement that would preserve the rights of British citizens currently living in the European Union as well as those of EU citizens currently living in the United Kingdom. Debate over the matter will probably center on the date when EU citizens arriving in the United Kingdom and British citizens traveling to the European Union will no longer qualify for residence rights. (In any case, the decision probably will not threaten the status of people already living in the United Kingdom or European Union.) Negotiations to keep the border between Ireland and Northern Ireland free of controls will be more complicated, likely stretching beyond the third quarter. But the most controversial issue under discussion during the next few months will be the United Kingdom's financial contributions to the EU budget. The size of the divorce bill will spark intense debate between the two sides of the Brexit negotiations.

Migration Season Gets Underway

The tumult in the European Union will not deter migrants from trying to reach the bloc, however. During the summer, weather conditions in the Mediterranean Sea will be optimal for people making the voyage. The bloc will take several steps to try to curb the influx of economic migrants and asylum seekers. To begin with, border controls will remain in place around the main transit and destination countries. States may additionally roll out tougher policies on illegal immigration, including measures to increase deportations and to reduce benefits for migrants, to discourage people from trying to enter their borders. Finally, the European Union will try to work with migrants' countries of origin, along with the states they pass through, to sever migration routes — likely to little avail.

Italy will probably be the main entry point for economic migrants bound for the European Union, a position that could cause problems between Rome and its fellow governments in the bloc. Leaders in Italy will call for solidarity from its EU peers, appealing to member states to accept some of the migrants, but their requests will meet with tepid responses from a few nations, rather than yielding a redistribution plan. Surrounding countries may even try to close their borders with Italy to prevent migrants from crossing over. Considering that Austria has a general election coming up in the autumn, Vienna could become a particularly vocal critic.

As the summer sets in, the European Union will also try to make sure that its immigration agreement with Turkey withstands the warmer months. Brussels will likely assure Ankara that it will keep delivering the funds included in the agreement and may even revisit negotiations to expand the bloc's customs union agreement with Turkey. But the European Union is not yet ready to honor key promises, such as visa waivers for Turkish citizens, that are unpopular among voters on the Continent.

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