- The real risk from Catalonia will arrive this week, and depends on Puigdemont and Rajoy's next moves
- Triggering Article 155 may lead to renewed violence and weakness in Spanish stocks and bonds
- In the event of a negotiated settlement, euro weakness is likely to be limited
With news of the independence referendum in Catalonia causing euro weakness, markets are now focused on how the Catalan government will move forward against Madrid. Prior to the referendum, the leader of the local parliament (Carles Puigdemont) promised to push for a unilateral declaration of independence via the Catalan parliament within 48 hours. If Puigdemont fulfills his promise, the motion declaring Catalonia an independent state is likely to pass. Puigdemont may also choose to hold off on the motion and negotiate with Madrid instead. This is less likely as many Catalan politicians have suggested that negotiations are no longer possible. Thus the most likely scenario is that Puigdemont will move forward with a motion for independence in the Catalan parliament as this gives him the most leverage.
At that point, markets will be closely watching how Prime Minister Rajoy reacts. We see two possible scenarios:
Movement towards statehood, and the likely reaction from Madrid
In the first scenario, Puigdemont both declares independence and immediately moves to take control of local police and financial matters. In this scenario, Rajoy is highly likely to trigger Article 155, allowing the central government to take over the Catalan government. This will allow the Madrid to replace the local authorities with its own staff, while maintaining control until future general elections.
While triggering Article 155 is simple on paper, it comes with significant risks in practice. Firstly, news of Article 155 is likely to lead to renewed violence in Catalonia, and renewed pressure on Spanish stocks and bonds. Secondly, Rajoy’s position today is tenuous today at best, given that the opposition parties (PSOE, Podemos) have not clearly committed to supporting the use of Article 155. While Rajoy has enough votes to trigger Article 155 today, it may ultimately lead to his demise as the opposition parties have enough votes to demand his ouster.
Canada-style compromise, with more concessions for the region
In the second scenario, the Catalan government may choose to refrain from taking immediate steps to assert control over policy and financial matters, choosing instead to negotiate with Madrid. Following the central government’s previous offer to give Catalonia more concessions, Puigdemont commented that “this moment warrants reflection”. Similar to the outcome of Quebec’s independence referendum in Canada, Puigdemont may be able to win new powers for Catalonia, and establish the region as a 'nation' within Spain. Unlike other provinces of Canada, Quebec maintains direct control of taxation and even has its own diplomatic representatives in major countries.
The other option under this scenario would be for the Catalan government to call regional elections during this time, in order to cement support for its pro-independence agenda. Yet, this would be a risky strategy as recent polls have shown that the incumbent government may fail to form a majority in the event of future elections.
Limited impact today, but potential for serious political instability
All in all, the situation in Catalonia remains tenuous. In the event of a decisive move towards independence and the expected reaction from Madrid, serious political instability may follow. This would be euro-negative, as the previous narrative of a more politically unified Eurozone following Macron’s victory would be further diminished. If negotiations take place successfully, then the Catalan referendum is likely to have a limited impact on the common currency.