Key Takeaways
- The return of the EU fiscal rules has seen several European economies including France and Italy immediately fall into excessive deficit procedures.
- They are therefore required to reduce their structural budget deficits by 0.5 percentage points per year.
- But we expect pressing investment needs, the delayed feed-through of higher interest service costs, and political realities will continue to push deficits higher rather than lower over the next few years.
- Indeed, the recommendations in the Draghi report on European competitiveness point to higher investment spending and call for joint borrowing to fund this.
- Eventually, the complex array of exemptions that allow some high-deficit countries to sidestep the full extent of the fiscal rules will expire. At that point, the massive medium-term fiscal consolidations implied by the rules will cease to be credible.
- Therefore, the EU Commission will likely eventually water down the fiscal rules once again, rather than force a showdown with national governments. Changes could include more exemptions for investment spending, and slower deficit reduction.
- Nevertheless, potential flashpoints along the way to this outcome – including the expiry of the temporary adjustment period in 2027 and an array of national-level elections – may cause market volatility akin to the run-up to the recent French legislative elections.
Read the full article.