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Why Italy’s election and opposition in northern Europe could derail Macron’s plan to reform the euro zone

Key Points
  • The most supported parties in the Italian election want to renegotiate the EU's fiscal rules and increase public spending.
  • Current proposals to reform the euro zone are based on a higher-level of risk-sharing between the 19 countries in the euro zone.
French President Emmanuel Macron delivers a speech at the Sorbonne in Paris, France, September 26, 2017.
Ludovic Marin | Pool | Reuters

The rising support for populism across Europe is set to complicate the plans of French President Emmanuel Macron to reform the euro zone.

The pro-European Union (EU) leader, who defeated far-right candidate Marine Le Pen in the last round of France's 2017 presidential election, has said that Europe should harmonize its tax policies, establish a minimum wage in every country and have a euro zone finance minister and budget — among many other proposals that he says will integrate EU nations further.

But the rising support for anti-establishment parties across Europe — seen most recently in Italy's general election — could jeopardize Macron's proposals.

"Half of the Italian electorate supported anti-establishment parties. Independently of who forms the next government, it will be hostile towards the European Union," Danielle Haralambous, an analyst at the Economist Intelligence Unit (EIU), told CNBC over the phone.

Last Sunday's election in Italy resulted in a hung parliament, with strong support for the populist Five Star Movement (M5S) and the far-right Lega party. Soon, Italian politicians will start negotiations to form a new government, but it is clear that both M5S and Lega will have a strong presence in policy-making.

The fact that both wants to renegotiate the EU's fiscal rules and increase public spending is raising eyebrows in Berlin. "Germany will be more concerned with risk-sharing," Haralambous told CNBC.

Current proposals to reform the euro zone are based on a higher-level of risk-sharing between the 19 countries in the euro zone. This tends to be a sensitive issue for countries like Germany and the Netherlands because they don't want their traditionally healthier finances to be impacted by other countries with extreme high levels of debt.

"Populism will be a hurdle," Bas van Geffen, analyst at RaboResarch in the Netherlands, told CNBC over the phone, adding that euro zone reform will be a "long process."

Short-term objectives could be compromised

French President Emmanuel Macron and German Chancelor Angela Merkel during a press conference at Elysee Palace on August 28, 2017 in Paris, France.
Aurelien Meunier | Getty Images

The European Council is expected to give the green light to proposals to transform the European Stability Mechanism (ESM) into a European Monetary Fund, similar to the International Monetary Fund (IMF), and to continue the banking union — a set of rules to supervise European banks — in June.

But the instability in Italy could derail the timeline. "Italy has set the agenda back," said Haralambous, adding that without a government in place in the euro zone's third largest economy, it is "unlikely" that there will be real progress in three months' time.

In the meantime, there are growing voices in different capitals cautioning against further integration.

Finance ministers of eight European countries, including Ireland, the Netherlands and Finland, wrote a letter earlier this month arguing that member states should focus on "implementing structural reforms" and "respecting" European fiscal rules —which stipulate ceilings for deficit and public debt —rather than promote changes at the European level.

"Decision-making should remain firmly in the hands of member states," they said in the letter, advocating that this is how to "regain public trust" and fight back against populism.

Although the new German government is expected to support, alongside Macron, the push for further euro zone reforms, new measures will also have to be approved by other countries. Speaking last week, Dutch Prime Minister Mark Rutte said: "It's not a French-German Europe," indicating that the Netherlands is likely to raise some opposition to some of the ideas to reform the euro area.

According to Geffen from RaboResearch, it is "hard to say whether they (EU) will find common ground and if they do, whether it will be enough to protect the euro zone against future financial shocks."

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