- After appearing to be delayed last week, threat of Article 155 is flaring up again
- Unilateral declaration of independence still unlikely, with negotiations the most likely outcome
- If Catalonia did move to break off or if Madrid triggers Article 155, euro to sell off on political risks
This morning, Catalonia’s President Puigdemont faced a 10AM CET deadline to clarify whether or not the region had formally declared independence. In accordance with Article 155 of the Spanish constitution, if a region acts in a manner that gravely attacks the general interest of Spain, the government must first notify the First Minister of the region. If no reply is received, the Spanish government (with an absolutely majority in the Senate) may force the region to comply directly with its directives.
Recent developments point to more political uncertainty
While Puigdemont’s letter this morning to Spanish Prime Minister Rajoy sought to defuse the threat of Article 155, he failed to directly state his intentions regarding independence. As such, the deadline has now been extended to Thursday 10AM CET, according to a recent televised speech by Spanish Deputy Prime Minister Saenz. Puigdemont’s letter reiterated his “sincere” offer for dialogue as a means of exploring the independence question. If Madrid triggers Article 155, the Spanish government can dissolve the current Catalan government and take direct control of its finances and police force. After asserting control, the central government is then likely to call snap elections.
After rising last week, Spanish stocks fell this morning after Puigdemont’s letter was made public. Following optimism for negotiations last week, today tensions are again increasing as the ‘nuclear option’ of Article 155 is becoming more likely.
Impact on the euro as tensions escalate
The worst-case scenario for the euro is for Catalonia to declare independence unilaterally or for Madrid to trigger Article 155. In both of these cases, we expect the euro to weaken and for Bono-Bund spreads (the yield differential between Spanish and German government bonds) to widen considerably. Historically, the euro has weakened on rising political risks that have threatened the integrity of the economic region. Recent examples include Merkel’s weak performance in the latest German elections and the threat of Marine Le Pen winning the French elections.
However, the possibility of full independence or Article 155 being triggered remains limited. Instead, the most likely outcome is for Puigdemont and Rajoy to engage in direct negotiations. Under this scenario, Puigdemont is likely to win new concessions from Madrid, while avoiding outright independence. Following talks, a compromise scenario is also likely to pave the way for elections in Catalonia in the near future. Given the weak performance of pro-secessionist parties in the latest polls, elections are likely to dampen the independence movement in the near term.
While our view is that outright Catalan independence is a remote scenario, the issue has continued to weigh on the common currency. We had earlier remarked that the euro was due for a good rebound after falling into short-term oversold conditions last week. Given ongoing political risks clouding the future, the rebound appears to have stalled. Accordingly, we lowered our short-term outlook on the euro to neutral this morning.