Heading into the European Council meeting in Brussels this week, European Union leaders face a packed agenda as they move to define the EU’s overall political direction and priorities. At the forefront are pressing issues around migration, security and economic policy.

The EU has its origins in the years following World War II, aiming to promote a peaceful, united and prosperous Europe. The fact that it has grown from six to 28 member states highlights the benefits and success of this political and economic union over the past 68 years.

However, the European political landscape has undergone a significant transformation in the past decade, as strikingly illustrated by the UK’s decision to exit the EU. British voters are not alone, with growing support of populism across the EU now challenging the status quo on a wide range of issues, including immigration and economic policy.

Growing tension over established economic issues and broader policy is moving closer to the centre of the political spectrum. This shift toward populism has been most dramatic in the larger EU countries, which together represent over 70% of the bloc’s GDP. This is creating uncertainty and potentially higher risk for investors.

The rise of populism in Europe

Italy’s new government is challenging the status quo

Italy made headlines when elections in March favoured two populist parties, challenging the EU’s migration policy, strict fiscal rules and the future of the euro. It’s reasonable to expect a confrontation between Italy and its European partners over the near term. In fact, we’ve already seen Italy’s hard-line stance on migration and the appointment of eurosceptic politicians to head important budget and finance committees in parliament.

Immigration dispute puts Germany’s coalition government at risk

Italy is not alone in its hardening attitudes toward immigration. In Germany, the shifting attitude on migration has created a sharp rift between Chancellor Angela Merkel and her Interior Minister, potentially jeopardizing the coalition government that was formed only a few months ago after long negotiations. The Interior Minister has threated to enforce Germany’s borders, presumably fearful of his party losing ground to populist, anti-immigration parties in upcoming state elections. However, disrupting the free movement of people would strike at the very foundation of the EU goals and values that Merkel has championed.

Preparing for Brussels

Chancellor Merkel has made some initial progress, issuing a joint declaration with French President Emmanuel Macron that includes proposals on stricter enforcement of the EU’s external borders, further mechanisms to strengthen the euro as well as a Eurozone budget to help alleviate interregional inequality. But whether the French-German resolve is enough to build a broad consensus with European leaders and, more importantly, their constituents remains to be seen.

Sun Life Granite Portfolios: turning cautious – for now

While there is no shortage of news around trade and geopolitics, internal political developments in Europe matter. The EU represents approximately 20% of both global equity market capitalization and GDP. Indeed, the recent political tension has caught the attention of investors with Italian bonds coming under pressure and the Euro falling against the U.S. dollar over the past few weeks.

In the context of these structural challenges, we have (for now) implemented a more cautious position towards Europe in the Sun Life Granite Portfolios.

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