Contours of Europe

As battle begins, 3M solution beckons

The battle over Britain’s place in Europe and the continent’s future shape is underway. With the contours starting to become a little clearer, several predictions now look reasonable.

Britain’s divorce negotiations from the European Union, which can start following last week’s delivery of the Article 50 letter, will be relatively civilised. Some acrimony and tantrums are inevitable. The UK has to try to prove that a non-EU future will be bright. The other 27 EU members must show that the British will be poorer and unhappier, to promote EU27 solidarity and prevent disintegration.

Based on last week’s initial exchanges of ideas, it’s possible to see how compromises can emerge. Decisions must be reached on trade in goods and services, on the City of London, on migration (including the rights of EU citizens in the UK and British people in the EU), and on budgetary commitments.

Germany is indicating that London’s willingness to provide some certainty over UK funds flowing until the end of the EU’s 2014-20 budgetary period would help prepare a framework trade deal. This would include a generous phasing-in period. Theresa May, British prime minister, will be wary of repeating the pre-referendum mistake of David Cameron, her predecessor, of relying too much on Germany. Yet there will be one strong difference. Cameron persuaded Berlin that the UK was likely to stay in after the June vote. May will be encouraging belief that the British could walk away from a ‘bad’ deal – which would leave the EU cash-starved.

Angela Merkel looks likely to remain chancellor for a fourth term after Germany’s elections in September. She has vital experience and status; yet she and the electorate have grown tired of each other. Social Democrat Martin Schulz, who is sharing power with Merkel in Berlin’s grand coalition, has raised his party’s poll performance by reconfirming its attachment to left-wing economics and European integration.

Yet Schulz’s aspirations have looked as improbable as his ‘outsider’ credentials, gleaned from a previous role as European parliament president. He and his pretensions were badly dented when his party handed Merkel a victory in the Saarland state election on 26 March. She will probably remain ahead in the autumn. The prize will be to lead another coalition.

The European Central Bank will stick to ‘making haste slowly’ over monetary normalisation, allowing the euro to stay weak and recovery to gain momentum as the US Federal Reserve gradually tightens credit. Jens Weidmann, Bundesbank president, has refrained from criticising the ECB’s slowness in raising negative interest rates or phasing out quantitative easing. Klaas Knot, president of the Dutch central bank and the most vocal of the ECB’s ‘hard money’ faction, has stated that rate increases should come only after bond purchases have been adjusted. Although a slight tightening of deposit rates cannot be ruled out, the first cuts in lending rates will almost certainly not come until after Germany’s elections.

Berlin will not disturb chances for co-operation with Paris after France’s presidential elections in April-May and its June parliamentary vote. Germany will engineer a deal this summer, involving further debt rescheduling with the International Monetary Fund and Greece over the next tranche in the Greek bail-out. This is part of the three-cornered compromise that includes further German and European refinancing to secure the IMF’s own funding.

Victory next month for Emmanuel Macron, the former economy minister and Rothschild banker, would greatly comfort Berlin. But with robust performances from Marine Le Pen and Jean-Luc Melenchon on the right- and left-wing fringes, France still presents Europe with the greatest risks. A 3M outcome – May, Merkel and Macron – would give Europe a good chance of stability over the next two years. The probability that this will happen is now rising.

David Marsh is Managing Director of OMFIF.


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