Beyond the French « No » vote…

The European Union’s Nice Treaty was widely perceived as a disappointment in terms of bringing much needed progress on reform and innovation ahead of the challenges of enlargement. The new Constitution proposed significant improvements on these issues with main points of interest for the markets being improving the flexibility of decision making in the enlarged Union delegating power from national governments towards the Union.

A French "No" vote to the Constitution would jeopardise these achievements. The strength of opposition in opinion polls has taken France by surprise. Over the past two weeks, however, it seems that the "Yes" camp is adopting a more aggressive strategy. All members from the main French parties, including the UMP and the Socialists, have been mobilized. The next two weeks will be key to determine how the odds are turning.

So far it appears that there is no clear plan B in case of a "No" vote from France. Indications are that the ratification process in other member states would continue. Therefore, the capacity of manoeuvre for France in any future renegotiation process will be linked to the prospects of other member states also joining the "No" camp.

I am doubtful that the EUR will suffer significantly versus the USD. The "No" vote should not be interpreted as a political mandate from the electorate to destroy euro-zone. Also, the lack of improvement in US twin deficits limits the capacity for the USD to establish a structural positive trend against the EUR.

In my view, the impact is more likely to be felt on the periphery of the Union, namely on Turkey, where the risk of a setback in the EU accession process could prompt capital flight after last year’s heavy inflows, against a backdrop of a declining carry attraction of the TRY and a wide current account deficit. The currencies of some new EU members, especially PLN and HUF, are also at risk from a setback in financial convergence expectations, as the lack of political
visibility in the Union could weaken the political commitment to speed up public finance reforms in the next couple of years. The near-term political agenda in Poland and the persistent twin deficits in Hungary would reinforce the negative impact on currencies.