NEWS Focus

German election: Merkel wins as expected but building a coalition will be hard work

As expected, German voters endorsed the ruling “Union” (CDU/CSU) as the leading party for the fourth time in this weekend’s parliamentary elections, with their coalition parter, the Social Democrats (SPD), coming in second.

The Anti-EU and anti-immigration party Alternative für Deutschland (AfD) becomes the third-strongest faction and for the first time enters the “Bundestag”. Angela Merkel will most likely remain chancellor and form a government with the Liberal Democrats (FDP) and the Greens. However, a “grand coalition” with the SPD could still become the final option after protracted negotiations. While the result slightly increases the uncertainty about Germany’s future European policy, we only expect a limited impact on financial markets.

Ruling party’s vote share plunges
Angela Merkel will most likely remain Germany’s chancellor for a fourth term. If she finishes her next four years in office in 2021, she will have been the longest leading chancellor alongside her former mentor Helmut Kohl. Despite the victory of the CDU/CSU, also known as the Union, it lost almost 9 percent of votes and its vote share of only 33 percent (246 of seats, see chart) is a much smaller than expected. The question now is what the next governing coalition will look like.

No more “grand coalition”?
After Martin Schulz, the leader of Social Democrats (SPD), already ruled out another four years in a governing coalition with the Union, the situation remains delicate. There are two possible coalition partners left: The Greens (Grüne Partei) and the Liberal Democrats (FDP). However, the probability of a coalition with these two junior partners is still quite small as it would be prone to a break-up. While the FDP wants to cut taxes substantially, decrease redistribution and is opposed to closer integration in Europe (and the euro zone), the Greens hold diametrically opposing views, e.g. on European integration. On top of that, the FDP is hardly willing to invest heavily into a stronger environmental policy – a key demand of the Greens.

Poor record for minority governments in Germany
A second possibility for the Merkel’s Union would be to form a minority government with the FDP as a single coalition partner. Yet this wouldn’t bode well as there were only three very short periods (some days to a maximum of four months) in Germany with a minority government leading the country. In particular, such a coalition has the potential to bring some – albeit moderate – changes to German politics. The FDP is skeptical towards French President Emmanuel Macron’s ambitions for more EU and euro zone integration (watch out for Macron’s speech tomorrow at Sorbonne University). Furthermore, it would support the EU-skeptical views of​ ​parties in France (Front national) and Italy (Lega Nord and Movimento 5 Stelle).

Their might still be life in the old dog yet
As the SPD has witnessed its weakest vote result since the Second World War, the probability for the second-largest party to form a government (together with the Greens and Die Linke) is very low. So despite its leader’s ruling out of a “grand coalition”, the SPD may still end up forming a government with Merkel’s Union if other political options fail. This would mean another four years of solid and steadfast German politics in the heart of Europe.

Difficult times for Europe?
However, the strong showing of the anti-EU and anti- immigration party Alternative für Deutschland (AfD, see chart) will probably boost the morale of populist forces that seemed to have been sidelined after the French presidential elections. The renewal of the strong partnership of the two largest countries in the EU, Germany and France, now may appear in question. Should populists continue to gain ground, for instance in Austria’s general elections mid-October, anti-EU and anti-euro movements in Italy could benefit and carry the day in the parliamentary elections there.

Implications for financial markets
The resulting uncertainty about the next German government and in particular about its stance on a possible further EU integration might weigh on the euro. In addition, the spreads between the German government bond Bund and the sovereing bonds in European “peripheral” countries could widen. However, we expect the impact to be quite contained. The German result may serve as a reminder that established European parties need to address peoples’ fears regarding further EU integration and migration again and again. The next sentiment indicator will be the elections in Austria, but the major focus lies on the forthcoming Italian elections that​ ​will take place between now and May 2018. We will keep a close eye on any renewed wave of populism in Europe.

vontobel german election merkel wins as expected but building a coalition will be hard work

Christophe Bernard - Chief Strategist - Vontobel Asset Management