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Merkel's 'hollow victory' raises questions over EU reforms

Merkel's 'hollow victory' raises questions over EU reforms

Angela Merkel has secured a fourth term as chancellor in Sunday’s election, however she is facing a potentially unstable coalition, which is expected to make it more difficult for her to drive through EU reforms. 

Her Christian Democratic Union (CDU) and Christian Social Union (CSU) sister party secured 33% of the vote, but this was down from 41.5% in the 2013 election.

Perhaps more eye-catchingly, anti-immigration party Alternative for Germany (AfD), won 12.6% of the vote, marking the return of the far right to the German parliament for the first time in over five decades, with the Social Democratic Party (SDP) polling just 20%.

‘This is a fairly hollow victory for Angela Merkel, who will have to negotiate a more complex coalition agreement against the backdrop of the AfD breaking through into the mainstream,' said Lucy O’Carroll, chief economist at Aberdeen Standard Investments.

'Anyone who might have thought that European political risk had disappeared will have had a rude awakening.’

She added that the result may jeopardise Merkel’s partnership with French president Emmanuel Macron to push through significant EU reforms, ‘as she is likely to be preoccupied fighting domestic challenges’, as she forms a coalition from a weakened position.'

Gavekal economist Cedric Gemehl agreed, saying: ‘This likely means that Emmanuel Macron must lower his sights on a move to more federalist solutions. This does not mean that eurozone reform is dead, but it does mean that the focus will remain on strengthening existing institutions rather than building new ones.’

Echoing O’Carroll and Gemehl, Heartwood investment manager Jaisal Pastakia pointed out that the result and a possible coalition with the Greens and Free Democrats (FDP) leaves questions about what the new approach ‘to the European project will be’.

‘FDP’s [Christian] Lindner has made it clear that he is not a fan of Macron’s vision of Europe. It leaves more uncertainty about how Europe moves forward towards its integrationist vision,’ he said.

On Brexit, O’Carroll added: ‘It may not mean much for the UK’s Brexit negotiations in the short term, as these are being led by Michel Barnier rather than the individual EU member states. In the longer-term, however, it could well increase the EU’s reluctance to make many concessions for fear of putting more wind in the populists’ sails.’

From a domestic point of view, with the SDP ruling out a grand coalition and the CDU/CSU not willing to work with the AfD, the Greens and FDP will have a strong hand when it comes to wringing concessions from Merkel.

Gemehl expects the FDP to push for control of the finance ministry and the Greens, the foreign office, which could result in a change of policy.

‘One by-product of such a coalition is that the reign of Wolfgang Schäuble will likely end at the finance ministry. As the godfather of Germany’s austere response to the post-2010 eurozone crisis, the question is whether his exit means a new fiscal course is set,’ Gemehl said.

‘Within Gavekal there are different views on this point, with Anatole [Kaletsky] believing that Merkel may be given a new lease of life by Schäuble’s exit, while Louis [Gave] sees a CDU that has moved to the right sticking with the Schäuble blueprint, which remains the finance ministry’s and Bundesbank’s default operating position.’

Gavekal warns that risk assets could be hit short-term, given the uncertainty. The euro is down against the US dollar, European equities have dipped, although German bund yields are broadly unchanged, with Pastakia highlighting that there is a ‘slight feeling of disappointment from financial markets’.

In light of this, the BlackRock Investment Institute said in a note: ‘We prefer European equities over government bonds and credit amid a sustained, above-trend economic expansion and a steady earnings outlook. Companies with much of their cost base overseas should have some cover against a strong euro in the short term, we believe.

‘We see scope for the US dollar to regain some ground against the euro as the Fed presses ahead with policy normalization and US inflation looks ripe for a rebound. We believe core inflation in the eurozone is likely to stay muted, keeping the European Central Bank accommodative.’ 


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