Now that the UK has avoided (at least for now) a hard Brexit as it negotiates to extend Article 50, investors might reasonably wonder whether they can relax for a moment and take stock of the bigger picture. What sort of longer-term future does the European Union (EU) have, irrespective of the UK?
A recurring theme of the Brexit narrative has been that the UK is negotiating from a position of weakness while the EU holds all the cards. Step outside that narrative and look at the EU from a broader perspective, however, and it cuts a less formidable, more fallible figure.
Brexit is one of many challenges the EU faces. At a fundamental level, the EU is struggling with the limitations to what a currency union can achieve without the support of a fiscal union, and the economic and political issues that such an anomaly can cause.
The economic issues are clearly visible in Greece and Italy, where lack of fiscal discipline has resulted in excessive debt. While non-EU countries might fix such problems through currency devaluation, this option is denied to Greece and Italy because of their euro area membership.
This has helped to create social tensions, the political consequences of which have included a rise in populism―a trend likely to become more entrenched if, as expected, populists gain ground in the European Parliament elections to be held in May.
These issues are important from a policy perspective―a fact that investors, in our view, should consider when looking at the EU longer-term. Ironically, the Brexit process, despite the EU’s apparent upper hand over the UK, has exposed some of the EU’s weaknesses in this respect. While for now euro area growth is low but stable, and political stresses remain under control, in future the EU needs to rise to a number of challenges if it is to continue on its successful journey.