This report was first published on Sept. 18, soon after the German election
While Angela Merkel’s conservative alliance was the biggest winner in Germany’s general election, a collapse in support for mainstream parties has left a pall of uncertainty over the country’s political future — and could end up influencing the future of the eurozone.
Merkel’s Christian Democrats and its Bavarian sister party — an alliance known as the CDU/CSU — logged their worst result since 1940 with around 33% of the vote, according to preliminary results.
At the same time, the Social Democrats — the CDU/CSU’s junior partner in the last coalition government — suffered their worst election since World War II, with 21% of ballots. That means the two main centrist parties lost almost 15 percentage points.
“The German elections have delivered the almost unexpected,” said Carsten Brzeski, chief economist for Germany at ING.
“With this outcome, there are only two coalitions possible: a continuation of the current grand coalition (CDU and SPD) and an unprecedented ‘Jamaica’ coalition of CDU, FDP, and Greens. However, none of these two coalitions will be easy,” he said.
The liberal Free Democratic Party secured roughly 10% of the vote, while the Greens came in just shy of 9%. Alternative for Germany, or AfD, was set to scoop up about 13%, marking the first time a far-right party has won a seat in the Bundestag in more than 50 years.
The fragmented result means Germany could face months of coalition negotiations. Whoever Merkel chooses as her partner — or partners — could determine Germany’s political direction for the next four years, including on issues such as the EU and immigration.
“Any new German government will be pro-EU, but there are huge differences on how they want to reshape the architecture of the eurozone,” Brzeski said.
One of the major topics is cross-border integration, via moves such as appointing a eurozone finance minister and adopting a common eurozone budget. That means a more streamlined and unified approach to balancing the pressure on the euro.
But the potential coalition partners differ greatly on this point. The FDP, for example, opposes this kind of deeper integration, calling for tougher fiscal discipline within the union.
“That is a completely different vision for the future of the eurozone than the Social Democrats and the Greens have,” Brzeski said. “Merkel’s choice for a coalition partner could therefore have a big influence and make big differences on how the eurozone could look like.”
Impact on the markets
The euro EURUSD, -0.1442% dropped as the result became clear. Early Monday, it bought $1.1903, down from $1.1948 late Friday in New York. Meanwhile, Germany’s DAX 30 index DAX, -0.23% was slightly higher at 12,602.59, while the yield on 10-year German government bonds TMBMKDE-10Y, +1.05% slipped 1 basis point to 0.442%.
In the longer term, the impact on the financial markets could be even bigger, analysts said. That’s because the coalition partner may claim the high-profile post of finance minister, which in turn could affect the choice of the next European Central Bank president.
The makeup of the coalition could also affect Germany’s stance on how much leeway to give economically weaker countries in the eurozone periphery.
If Germany’s current finance minister, the CDU’s Wolfgang Schäuble, ends up having to give up his post, where he goes next is another weighty factor. He’s expected to aim for one of the several EU and eurozone presidencies set to become available in the next few years, such as the European Commission President or the eurozone finance minister, if that post is adopted.
Having a German in one of those roles and as head of the ECB may be too much to stomach for the other member states. That increases the chances of a non-German running the central bank when ECB President Mario Draghi, an Italian, leaves in 2019, according to UBS.
“This may imply a slower policy rate normalization path, and lower euro and eurozone bond yields than with a German ECB president,” the strategists said.
“Investors are therefore well advised to monitor the future of the German finance ministry and the implications for European positions such as the ECB presidency,” they added.
The coalition possibilities
So who is in the frame to partner up with Merkel’s crew in a governing coalition?
After Sunday’s election, there are just three parties that are seen as having a serious chance of landing the spot as junior partner: The Social Democratic Party, or SPD; the liberal Free Democratic Party, or FDP; and the Greens.
Here’s where they stand on eurozone policies:
The SPD: Headed by former European Parliament president and die-hard EU fan Martin Schulz, the SPD supports further eurozone integration, putting him in the same camp as newly-elected French President Emmanuel Macron and European Commission President Jean-Claude Juncker.
After four years as a junior partner in a grand coalition with the CDU, the social democrats have made it clear they prefer not to back Merkel again. And after the stinging setback in Sunday’s election, the party said it will return to opposition and try to rebuild its voter base. However, the CDU has urged the SPD not to rule anything out, seen as keeping the door open for another grand coalition.
The Greens: On Europe, the Greens have called for an European Monetary Fund to help struggling member states and have embraced reform proposals for a eurozone budget and finance minister.
The FDP: Is taking the opposite view on reforms. The party wants to toughen up the fiscal rules and advocates for each member state to take more economic responsibility. It’s leader Christian Lindner wants a harder line on Greece and has suggested the struggling nation be granted debt relief and forced out of the eurozone.
“Merkel would probably try to keep a pro-Eurozone course but the FDP would clearly slow down any Merkel-Macron attempts for deeper Eurozone integration,” Brzeski from ING said.
If Merkel fails to team up with the SPD for another grand coalition or doesn’t secure the “Jamaica” government, she could end up having to run a minority government with either the FDP or the Greens, he explained.
“In any case, the weak result could make Angela Merkel a lame duck much faster than international observers and financial markets think. The combination of a weak result together with a difficult coalition and possible tensions (within a new coalition but also her own party) will not make Angela Merkel’s political life any easier,” Brzeski said.