Mid-year policy outlook: Europe

European Union

EU political outlook

• The countdown to the next round of EU-level elections has begun. Voters across the EU’s 27 member states will go to the polls from 6-9 June 2024, to elect their representatives in the European Parliament. Historically, the European Parliament has been led by a pro-EU coalition of the centre-left Socialist and Democrats Group (S&D) and the centre-right European People’s Party (EPP), enabled by the centrist Liberal Democrats (Renew Europe). However, recent national elections, such as in Italy and Finland, as well as regional elections in Germany, suggest that certain EU countries are shifting politically to the right, a trend which could be reflected in the composition of the next European Parliament to the detriment of the centre-left and, more broadly, to the historic pro-EU coalition.
• While such an outcome would, of course, have implications for the European Parliament’s contributions to the EU’s legislative process, it would also have wider ramifications for the formation and appointment of the next European Commission, which has the exclusive right of legislative initiative. As Europe faces up to some of the most difficult economic, social, and geopolitical challenges it has faced in recent decades, it can ill afford further political fragmentation within its administrative institutions. To overcome these challenges, it will be imperative that the EU’s political class can, in the next 12 months of campaigning, prove to voters that their needs are best served by voting for those who support the EU project rather than those who rail against it.
  

EU fiscal outlook

• The suspension of the EU’s Stability and Growth Pact will be lifted at the end of 2023, meaning that EU member states will be expected to return to a sustainable fiscal footing in line with the European Commission’s expectations or else face corrective action. As such, EU leaders have between now and the end of the year to agree on what such budgetary discipline looks like in a post-COVID-19, post-energy crisis world and in the face of continued geopolitical and economic uncertainty stemming from Russia’s invasion of Ukraine.
• Europe will not simply return to pre-pandemic budgetary restraint, however. The European Commission is planning an interim solution that would put EU member states back on the path towards a common fiscal policy over the medium term while also reengaging excessive deficit procedures in Spring 2024 for those countries unable to sufficiently rein in spending.
  
• Meanwhile, the EU is soon expected to launch a European Sovereignty Fund – the EU’s answer to the US Inflation Reduction Act – which aims to support growth in Europe’s green/clean tech industries. However, given the significant economic pressures facing EU capitals, we do not expect that the European Sovereignty Fund will be able to match the fiscal firepower of the US act, at least not in the short term.
  

EU Geopolitical outlook:

• The Russian invasion of Ukraine remains front of mind for EU leaders, having recently announced an 11th package of sanctions since the war began. As Europe continues to provide economic and military support to Ukraine and has, for the time being at least, brought the energy crisis under control (see below), attention is now turning to the establishment of a recovery fund for Ukraine.
• Discussions regarding the size of the fund are at an early stage; however, initial estimates suggest that around EUR 400 billion could be raised through a mixture of EU borrowing and, potentially, the deployment of Russian assets seized by the EU. Progress towards EU member states’ return to fiscal sustainability will no doubt play a role in these discussions, but political support for Ukraine across the bloc remains resolute.
  
• Meanwhile, the EU’s relationship with China continues to become ever more stressed despite diplomatic efforts to de-escalate tensions. US-led discussions within the G7, which aim to impose export restrictions on China and reduce critical supply chains dependent on China, are complicating the EU’s idiosyncratic ambitions to improve market access for European companies in China and to advance trade in support of the climate transition.

Policy and regulatory outlook

Banking reform

• While the European banking sector proved resilient in the face of recent crises in the US and Switzerland, the EU intends to enact legislation that would broaden the application of resolution tools, including for small and medium-sized banks, and further harmonise the way in which national deposit guarantee schemes (DGSs) are used during crisis periods, including in respect of uncovered deposits.
  
• Despite a renewed emphasis on ensuring the continued resilience of the banking sector, the EU’s ultimate goal of creating a European Deposit Insurance Scheme (EDIS) remains elusive, and it will fall to the next European Commission to determine the best way to achieve this ambition during the 2024-2029 political cycle.
  

Energy

• The EU is emerging – tentatively – from the energy crisis which engulfed the region following the Russian invasion of Ukraine. Having diversified its energy supplies, replenished gas storage reserves, and implemented a targeted energy price cap, political attention is now turning to preparations for the coming winter and the imminent operationalisation of the EU’s recently established Energy Platform – a mechanism facilitating natural gas and LNG (and in the future hydrogen) demand aggregation and joint purchasing by companies from the EU and the Energy Community, and a key component of the EU’s plans to ensure energy security.
  
• Significant resources will also be allocated to implementing key elements of the EU’s Fit for 55 agenda – an initiative that would see the EU reduce its greenhouse gas emissions by at least 55% by 2030. This includes hugely ambitious measures to increase the use of renewable energy while reducing energy consumption and to introduce a Carbon Border Adjustment Mechanism (CBAM), which will apply a carbon price to certain imports (e.g., cement, iron, fertiliser, electricity, etc.). The EU hopes to finalise all 17 measures before the European Parliament elections next year.
  

ESG

• Having introduced far-reaching ESG and sustainability-related rules at breakneck speed over the past few years, the EU will attempt to focus on implementation and, where necessary, clarification of its ever-expanding regulatory framework.
  
• This includes finalising the technical standards underpinning the EU’s corporate sustainability reporting framework and achieving a political agreement on sustainability due diligence requirements for firms, which aim to put an end to corporate activities that give rise to adverse environmental and human rights impacts.
  
• Notwithstanding this apparent pause for breath, in the near term, we still expect the European Commission to bring forward a proposal to regulate ESG rating providers and, more broadly, publish further technical amendments to the EU taxonomy for sustainable activities ahead of firms’ reporting obligations starting in 2024.
  

United Kingdom

UK political outlook

• 2024 will almost certainly be a general election year in the UK, with an autumn date most likely. Following a painful set of local election results for the Conservatives in May, Prime Minister Rishi Sunak is under pressure from his Members of Parliament to show he can close the gap on Labour’s 15+ point poll lead before then.
• Sunak will look to use the Tories’ annual conference in October and the autumn economic statement to pitch his election message to voters. He’ll argue that his medicine for the UK economy is working, with higher growth and lower-than-forecast borrowing enabling him to dangle the carrot of future tax cuts if voters stick with him.
  
• The Labour leader, Keir Starmer, is under pressure too from a media narrative that has shifted from the widespread expectation of a Labour majority at the next election to the probability of a hung Parliament and a Lib/Lab coalition. While Labour still enjoys a big polling lead, support for the Labour leader remains soft, suggesting many voters remain unconvinced by his leadership.
  
• For both Starmer and Sunak, gaining political momentum in the next six months will be critical to their electoral chances next year.
  

UK fiscal outlook

• Having endured International Monetary Fund (IMF) spring forecasts that predicted a recession this year and the lowest GDP growth in the G7, the revised UK outlook for the rest of the year is now marginally brighter: Government borrowing is now forecast to undershoot official forecasts by £15 billion, despite the impact of inflation on index-linked debt, and the IMF is now predicting annual growth of 0.4% rather than a 0.3% contraction.
• With a general election in the offing, this year’s autumn economic and fiscal statement becomes more significant, with Chancellor Jeremy Hunt likely to signal scope for personal tax cuts, both as an election sweetener and a riposte to internal party critics railing against the current level of taxation – the highest in the UK’s recent peacetime history.
  
• However, the chancellor will also need to factor in continuing headwinds from the effects of ongoing public sector strikes over pay settlements, energy prices and a recent, albeit small, uptick in unemployment as he deliberates over the government’s election offer.
  

UK geopolitical outlook

• Following recent years of fracture and friction, UK-EU relations are finally on an upward trajectory – Agreement of the Windsor Framework – resolving outstanding differences on the implementation of the Northern Ireland Protocol – has removed a major obstacle to enhanced UK-EU cooperation. In the minds of many political leaders on both sides, Brexit is now “done”, and they can turn to the future. Immediate benefits include the unlocking of formal financial services regulatory cooperation and renewed talks on UK participation in the EU’s Horizon scientific research programme.
• The UK will continue to apply diplomatic pressure to allies to supply Ukraine with more advanced weaponry in its defence against Russian aggression. Having won the argument on the supply of main battle tanks, the UK has successfully switched focus to the supply of F-16 jets, with US support. The UK government calculates that Russian options for escalation are limited and that a successful Ukrainian counteroffensive is the necessary pre-condition for a successful resolution to the conflict.
  
• On China, the UK will continue to attempt to balance national security concerns with economic interests. But through accession to the Comprehensive and Progressive Agreement for Trans-Pacific Partnership and a recent bolstering of defence cooperation with Japan and Australia in particular, the UK is inching towards supporting an economic and security strategy of China containment, together with the US and regional allies.
  

Policy and regulatory outlook:

Banking reform

• The fate of Silicon Valley Bank’s UK subsidiary aside, the UK sector has also proved resilient in the face of a sharp tightening of monetary policy. The verdict from the Bank of England is that UK banks are “well-capitalised, liquid, and able to serve their customers.”
  
• However, given that the pace of customer withdrawals was a factor in SVB’s demise, the government and regulators will continue to review whether the UK’s current £85,000 limit on deposit insurance needs to be raised, alongside a review of their stress-testing parameters.
  
• Relatedly, regulators will continue to assess the systemic risks to financial stability posed by non-bank financial intermediaries, working with international counterparts through the Financial Stability Board to develop proposals for reform.

Energy policy

• In recent years, UK energy policy has suffered from political instability as successive prime ministers have adopted different approaches. As we move toward the next general election, policy stasis is likely to set in. For example, major investment announcements on new nuclear – both large scale and small modular reactors – look set to be pushed to the other side of the election.
  
• In the spring budget, the chancellor committed to “complete our response” to the US Inflation Reduction Act in the forthcoming autumn statement. However, given that any fiscal headroom will likely be used to fund pre-election tax cuts, the response is unlikely to encompass meaningful expenditure in the short term.
  
• Nonetheless, in the coming months, we are likely to see some incremental policy progress in areas such as the government’s approach to bioenergy with carbon capture and storage and proposals for a UK Carbon Border Adjustment Mechanism.
  

ESG

• Following a March 2023 refresh of its Green Finance Strategy, we expect a flurry of policy announcements and consultations in the second half of the year from both government and the financial services regulators.
  
• The government plans to review the UK’s non-financial corporate reporting framework at the same time as proposing a mechanism by which new global baseline sustainability reporting standards and net zero transition plans can be incorporated into corporate disclosures.
  
• Following several years of hiatus, we expect the government to bring forward proposals for a UK Green Taxonomy in the autumn. However, the electoral timetable likely means that the taxonomy won’t go live until after the next election.
  
• In the meantime, the government plans to bring ESG ratings providers within the scope of the Financial Conduct Authority’s regulations, and the FCA will finalise its proposals for sustainability labels and disclosures for investment products, having postponed publication of its final rules until the autumn.