Following the SPD's decision to go into opposition, Angela Merkel will have to find a way to make a Jamaica coalition (CDU/CSU/FDP/Greens) work. However, Merkel will try to convince the SPD to continue with a grand coalition, so that an SPD comeback cannot be excluded. Given the complexity of a Jamaica coalition, negotiations could take 3-6 months. Our best estimate is that the new government will be in place in the first quarter of 2018.
The SPD recorded its worst election result since World War II and decided to go into opposition. However, Merkel did not accept that decision and will on the first day after the election try to convince Schulz to renew the grand coalition. It can therefore not be excluded, that the SPD could change its mind soon or at some point along the coalition talks. However, for the time being, the Jamaica coalition is the only available option, with talks set to be lengthy. There are large differences between the Greens and the FDP (on, for example, climate change, immigration and Europe). Even talks between the CDU/CSU and the FDP – its natural coalition partner – will be challenging given the FDP's position on Europe is markedly different from that of the CDU/CSU (phasing out of the European Stability Mechanism (ESM), allowing for an exit from the Eurozone, no Outright Monetary Transactions (OMT) for the ESM, automatic sanctions in the European Stability and Growth Pact, etc.). Nonetheless, a final compromise should still see European integration move forward in the coming years. That said, it is likely to be at a slower pace than currently envisaged by Merkel and Macron, and what it would be under a grand coalition.
We have already incorporated a c.0.5% boost to the German economy into our forecast in both 2018 and 2019, driven mainly by the fiscal side (with no wealth tax), rather than from any large scale structural reforms. Having the FDP in government would catch the markets by surprise, and may lead to slight support for the euro and a moderate widening in peripheral spreads.
The impact on German equities should be neutral in the short term as 70% of revenues of German MCSI firms come from abroad.
What are the key differences between the parties' policies?
The main point of agreement among the parties is the call for income tax cuts (from EUR 10-30bn), while large structural reforms remain absent. That said, the Greens focus on lower-income households and wish to increase taxes for high incomes, while the CDU/CSU and the FDP propose relief for all income ranges. The FDP calls for the highest income tax cuts, but only as long as the budget balance target is – at least – complied with and relies on the FDP's assumptions on the expected tax surpluses. We therefore think that any tax relief would be similar to the CDU/CSU's plans. Only the Greens (and the Left) carry a wealth tax in their manifestos, making the wealth tax unlikely in the next four years (also due to the highly fragmented upper chamber).
With regards to public spending, the FDP and the Greens favor higher public investment, but only the Greens have an explicit financial target (EUR 10bn). Coupled with the difficulty for the federal government in sourcing sufficient investment projects, we don't expect an incremental and material investment boost after the elections. In any event, there are also differences with regards to increasing defense spending. The CDU/CSU and FDP all aim to increase defense spending in compliance with NATO's target of 2% of GDP (currently 1.2%), with the Greens (and the SPD) being opposed to such an increase in spending.
On European policy, points of agreement include a hardline toward Brexit, a common defense policy and a European redistribution system for refugees. The Greens (and the SPD) go further and propose a common European budget, a European investment program and, together with the CDU/CSU, aim to transform the ESM into a European Monetary Fund. On a different note, the FDP has a less positive stance toward Europe, proposing for example less burden sharing, a phasing out of the European Stability Mechanism and creating the option for countries to leave the EMU without leaving the EU (in particular Greece). The FDP’s position could therefore complicate Angela Merkel’s pursuit of increasing Eurozone integration at the intended speed.
Another area of conflict between the FDP and Greens is that both parties have contrasting positions on energy and climate policies. The Greens wish to introduce a carbon tax and increase existing measures, while the FDP hopes to lower the energy tax. This includes the car industry, where the Greens want to prohibit the registration of cars with combustion engines from 2030 onwards (and are the only party who wish to do so). On the other hand, the CDU/CSU wants to increase subsidies on electric cars, while the FDP opposes both further subsidies and the prohibition of combustion engines by 2030.
AfD enters the Bundestag
After entering 13 out of 16 state parliaments since 2014, the AfD is entering the Bundestag for the first time since its foundation in 2013. The AfD's entry into and the FDP's return to the national parliament increases political fragmentation in Germany. The Bundestag will boast six parties – the highest number since 1953. If this becomes the new norm, coalitions of a large party and small party will be much rarer than in the past, given the reduced size of parties (i.e. more difficult to reach a majority).
In contrast, grand coalitions would be more frequent in the long term compared to post-WWII history, in our view, given the complexities of a three-way coalition compared to a two-way coalition. A political gridlock similar to Spain in 2016 is unlikely this year though, given the consensus driven political culture in Berlin.
Still, the AfD's surge also means that work in parliamentary committees and on contentious European issues, such as future bailouts for Greece, may become more difficult (especially if dissenting voices in the ranks of other parties, notably the CDU/CSU and the FDP, rise too). Given Germany's central role to the integrity of the Eurozone, more fragmentation might increase political uncertainty further.
Economy to benefit from election result
The impact on the economy will likely be favorable, given the planned stimulus package amounting to EUR 15bn or about 0.5% p.a. of GDP (mostly through tax measures) and additional infrastructure spending (R&D, digital and military spending). The CDU/CSU should be able to reduce taxes as long as the economy remains benign. Given the similarities to the FDP and the Greens manifesto regarding tax cuts, it may be able to count on the SPD's support in the upper chamber (changes to taxes require the Bundesrat's support). The residential housing sector should see additional support. Most of the planned funds are sourced from a strong economy and excess tax revenues, as a balanced budget remains a priority (in particular for the FDP). Even if digitalization may be a key priority for Merkel, we don't expect deep reforms such as the Agenda 2010, given the lack of pressure in a very benign economic environment.
Growth is therefore set to be boosted by fiscal easing of approximately ½% in 2018 and 2019, leading to our GDP growth outlook of 2.1% in 2017 and 1.7% in 2018 (see fig. 3). Our 2018 forecast therefore includes the aforementioned fiscal easing.
German coalition implications for the ECB
The CDU/CSU may have to give up the finance ministry to build a coalition. Becoming free after the German election, Wolfgang Schäuble would then potentially claim one of the numerous key European posts, such as, for example, the anticipated Eurozone finance minister post or the European Commission (see fig. 4). The current European Commission president – Jean-Claude Juncker – has already announced that he will not run in 2019. To bridge the gap, Schäuble could take up the Eurogroup presidency, as Jeroen Dijsselbloem is set to leave the Eurogroup by the time the new Dutch government is formed (expected by the end of 2017). With Schäuble running a European institution, the ECB would probably go to a non-German in 2019 as Germany already holds the presidencies of the European Stability Mechanism and the European Investment Bank. Given that the latter two institutions have direct fiscal implications for Germany, we expect the German government to wish to keep these positions. A German running the European Commission, Eurogroup or even the anticipated Eurozone finance minister post rather than the ECB may also be more investor-friendly as Schäuble at any of these institutions may mean more fiscal discipline in the Eurozone, but also an investor-friendly ECB.
Will the election drive the speed of European integration?
For European integration, another CDU-led government in principle will broadly mean a continuation of the new spirit of cooperation between France and Germany. More specifically the CDU/CSU is now working with a centrist rather than a socialist-led France, rekindling the relationship between the two nations. Macron and Merkel holding an unusual joint press conference after the June European Council is a case in point. Also, Merkel has suddenly opened up the possibility for a European treaty change, raising the specter of significantly more European integration.
The timing couldn't be better as almost all countries are now complying with the Maastricht 3% deficit criterion and the economy is doing well. Even France and Spain are about to comply and the European Commission has recommended releasing Greece from the Excessive Deficit Procedure (even before France and Spain). Greece has improved a lot, and its aggregate imbalances are no longer deteriorating (even if they are still big). Since the euro crisis, Germany has been adamant about demanding Eurozone governments to bring their fiscal houses in order before talking about fiscal integration measures. With Eurozone fiscal deficits set to average only 1.4% in 2018 according to the European Commission, the backdrop for European fiscal integration measures has changed considerably. In addition, the economic upswing has pushed up popular support for the Eurozone (see Fig. 5) with a recent German survey found 79% of citizens calling now for more integration.
As such, talk has started for example about a European finance minister with a small Eurozone budget, which would complement national budgets. Regarding a Eurozone finance minister and budget, Merkel said at a recent joint cabinet meeting with the French administration that "we can talk about it" and "we will surprise you in that respect." However, Merkel still rules out measures such as debt mutualization, while foreseeing a European Monetary Fund (i.e. an enhanced ESM with greater powers) and an EU defense union. Furthermore, the FDP landing in government is likely going to slow down the anticipated speed of European integration in the coming years.
Geopolitically, the CDU/CSU manifesto foresees no Turkish EU accession and on Brexit, it seeks to limit the damage to the German economy.
Coalition talks: Process
There is no formal coalition building mandate or law, rather an informal one for the party with the most votes. That said, parties (respectively their leadership committees) start exploratory coalition discussions immediately after the election (after the election in 2013, the CDU/CSU held talks with the Greens and the SPD).
These preliminary discussions are followed by formal coalition talks, which culminate in a coalition agreement. In 2013, the coalition agreement between the CDU/CSU and the SPD was signed almost three months after election day. A "Jamaica coalition" may take longer to conclude than a two-way coalition. However, it should become clear over the course of October who will take on the key posts in the forthcoming government. Furthermore, both the FDP and Greens have stated that they would hold a grassroots referendum on any coalition agreement.
The first convention of the new Bundestag must then be held by 30 days after the election, with the old cabinet staying in place until the new government is sworn in. One of the Bundestag's first remits is electing the next federal chancellor. However, before electing the chancellor, coalition discussions must be concluded. During this transitional period, the incumbent cabinet stays in office. In 2013, Merkel was re-elected chancellor one day after the coalition agreement was signed.
How and when will the chancellor be elected?
There is no deadline to elect the chancellor. After consultative talks with party and floor leaders, the federal president (currently Frank-Walter Steinmeier from the SPD) formally nominates a candidate, who must then be elected with absolute majority by the Bundestag. Until now, the federal president has always nominated the chancellor candidate of the coalition which is set to govern. Moreover, every candidate proposed was elected at the first onset in the past. If a candidate reaches an absolute majority, the federal president must declare the person chancellor.
If no absolute majority is reached at the first attempt, the Bundestag can elect a chancellor without consulting the federal president during a 14-day period. An unlimited number of elections (or none at all) can be held in this time.
If still no absolute majority is reached after this second election period, another election in the Bundestag is held immediately, but by simple majority (i.e. more yes than no votes are enough). After this last election, the federal president is free to declare the candidate chancellor even if only a simple majority is reached. Alternatively, the president can dissolve the Bundestag.
Given that coalition building is firmly part of the German political culture, snap elections or gridlocks like in Spain in 2016 are very unlikely. Accordingly, we expect the chancellor to be elected before year end. After being elected, the chancellor nominates the ministers, who are then confirmed by the federal president.
Ricardo Garcia - economist - UBS
Paula Patzelt - UBS