Today's edition of the Saxo Morning Call features the SaxoStrats team discussing the continuing weakness of the US dollar as commodity prices recover ground and in the wake of key US equity indices hitting all-time highs Thursday.
Article / 09 May 2017 at 9:22 GMT

Europe Divided: Nothing has been won just yet — #SaxoStrats

Head of Macro Analysis / Saxo Bank
  • Macron awaits May data, June legislative elections
  • French growth forecast for 2017 'likely overstated'
  • En Marche! set to obtain relative National Assembly majority

Emmanuel Macron

Macron has won the presidency in an impressive landslide, 
but his real work starts now. Photo: Shutterstock 

By Christopher Dembik

The sound of victory is reverberating through the streets of Paris, but nothing is won yet for the Élysée Palace's newest resident. The European agenda will soon be knocking on Emmanuel Macron's door again with the May 11 publication of the European Commission's spring economic forecasts and the May 17 French deficit assessment  – always a tricky exercise. 

France is lucky that the economic situations of the other Club Med countries are both much worse and much more complex from markets' point of view. Investors reaffirmed their confidence in France last week with its 10-year bond issue offering a lower yield than that of April (0.81% versus 0.97%).

Contrary to the regular howls of outrage from all sides, the risk of soaring borrowing costs has been sharply exaggerated in the short and medium terms. In 2007, France's debt burden represented around 2.5% of GDP compared to only 1.7% in 2016, lower than most European countries apart from Germany. 

Due to the average seven-year maturity of French debt, a 1% jump in interest rates would only have a 0.14% impact per annum on the debt burden – quite manageable! More immediately, the debt burden should continue to fall in 2017 and 2018 (towards 1.5% of GDP), thus giving Macron a grace period of just over 18 months with regard to public spending.

The real challenge for the new president will be stimulating the ailing economic machine, whose ills are reflected once again by lacklustre growth in Q1. The economy grew by just 0.3%, half as much as in Q1'16, hampered in particular by catastrophic external trade and stagnant household spending. 

With a carry-over of 0.7%, the government's official forecast of 1.5% for 2017 looks to be overstated. Accordingly, one of the new government's first economic actions could be to revise this year's target downwards, in line with the lower forecasts of international organisations. 

While this would be reflective of economic reality, though, it would also be a negative opening signal insofar as it would suggest that raising French growth towards 2% at a time when it is trending closer to 1% may prove a difficult proposition.

Like outgoing president François Hollande, Emmanuel Macron will be keen to strengthen the competitiveness of French businesses by cutting employment costs, but this will not help French economic growth gain momentum over the long term. 

France's benchmark CAC 40 equities index:
CAC 40

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Source: Saxo Bank 

The absolute priority is to stimulate productivity as historically, the two engines of growth are demography and productivity. In France, capital productivity is around average for developed countries; the problem lies in the level of labour productivity. This has been falling behind for 20 years, a worrying trend that can be explained by the following factors:

  • The low skills of the French population, as shown by the OECD's PISA surveys. France does not need legions of economists, managers, and academics; what it urgently requires are engineers, doctors, scientists, and manual jobs in the industrial sector. Over a third of French industrial companies report labour shortages. This is an appalling situation given that unemployment is hovering around 10%. 
  • A lack of innovations to modify production processes and consumer habits. This means that more needs to be invested in fundamental research. The budget currently allocated to the National Research Agency (around €640 million compared to €2.7bn for its German counterpart) is certainly not going to help France realise its industrial policy ambitions. 

The training policy that the new president wants to implement is a step in the right direction. There is no major financing problem. The real problem is that this policy is not channelled towards the right demographic categories and does not provide training programmes that will respond to the actual requirements of the job market. 

Furthermore, the super-regions need to be much more engaged in this process based on the obvious starting-point that the local level is best-placed to address improvements in the economic fabric.

To succeed, the new president still has to persuade the French people in the upcoming legislative elections on June 11 and 18. It is likely that the En Marche! movement will obtain a relative majority in the National Assembly, representing a third consecutive achievement. 

The lack of an absolute majority does not mean the president will be hamstrung, as we saw in the period between 1988 and 1991. Back then, Socialist prime minister Michel Rocard was faced with the same situation. Nevertheless, he managed to push through major reforms such as the CSG and RMI (social security contributions and social welfare benefits) by forming ad hoc alliances and using (abusing) the special powers of Article 49-3. 

There is every chance that history will repeat itself. The political lines are already shifting as key figures on both the left and right have indicated they are prepared to work with Emmanuel Macron. 

While forming a German-style grand coalition is a utopian idea over the long term, bringing together reformers in the country's interest seems credible… at least until politics regain the upper hand in time for 2019's European elections.

Macron must invigorate France's lacklustre economy if he wants to successfully quell the populist narrative posed by Le Pen and Mélenchon in the election. Photo: Shutterstock

— Edited by Michael McKenna

Christopher Dembik is head of macro analysis at Saxo Bank 
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This comment has been redacted
14 March
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Macron and his team will achieve a debt burden of 1.5% of GDP.


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