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German election result gives further support to eurozone recovery

The main result of the German election was no surprise but eurozone recovery could be shaped by the make-up of the new coalition government.

The result of this month’s German parliamentary election went as predicted with Angela Merkel securing the largest portion of the vote and her third term as Chancellor.

In the immediate aftermath of the election, the Dax index of the 30 largest companies remained effectively unchanged, suggesting that the outcome had largely been as expected by the markets and the result means there will be no sudden changes in government policy.

F&C Investments director of European equities David Moss says: “Markets are likely to take this vote positively as it should mean no change in the policies that have helped to improve the situation in the Eurozone in the last 18 months, albeit Merkel has been clear this will mean continued austerity.”

The one fly in the ointment is the fact that Merkel’s junior coalition partner in the last government was wiped out in this month’s elections and her CDU/CSU party will have to find new coalition partner.

Invesco Perpetual head of European equities Jeffrey Taylor says: “Expect some weeks of tough political horse-trading to begin. We would be surprised to see much reaction by the markets to such public wrangling, as the likely outcome is relatively clear, namely a government with a large majority in the Bundestag.”

The new government will be under pressure to press on with further reform to help maintain economic growth.

Taylor says: “A government with a large majority could be well placed to enact further structural reform measures in Germany, which many policymakers there feel had started to slip under the outgoing government. In any case, a government which is at least as pro-Euro and pro-Europe as the last one is certain.”

Just as the dominant political party in Germany remains the same, the dominant economic problem, whether or not to provide further support for struggling eurozone countries, also remain.

St James’s Place Wealth Management director of asset management Andrew Humphries says: “Germany faces two critical debates after the election: whether Greece and Portugal – and now Slovenia – will require fresh aid and on what conditions; and whether an authority to shut down failing banks and underpin a European banking union will buttress financial powers in Brussels and away from Berlin.”

One thing in Merkel’s favour is the strength of the Europe’s largest economy. The German economy grew by 0.7 per cent in the second quarter of this year and unemployment is at a post-unification low of 5.3 per cent.

Humphries says: “The eurozone is also clear of its prolonged recession, powered in part by its German engine room, with positive if faint second-quarter growth of 0.3 per cent. France registered 0.5 per cent growth in the same quarter, Greece managed 0.25 per cent and Ireland has also emerged from recession with 0.4 per cent quarterly growth. Meanwhile, September eurozone PMI show further signs of recovery in the third quarter. And the ECB has indicated it will keep market interest rates low to prise further growth from the eurozone.

“This renewed confidence is also playing out in the equity markets, with the FTSEurofirst 300 index up 13.5 per cent over the last year and hitting its highest level since mid-2008 last week. The MSCI Europe ex UK index has gained 17 per cent over the last year. Investors have even turned positive on European financials.”

But Moss says it is too early to start counting in further economic growth until all the political horse-trading has been completed.

“The hope and indeed expectation is that after such a resounding victory Angela Merkel can continue to drive the policies that have helped Europe to stabilise and move forward over the last five years but we must wait and see and hope for now,” says Moss.

The multi-manager’s view

O'Connor-Paul-Henderson-2013

Paul O’Connor, director of multi-asset, Henderson

The provisional results of Germany’s Federal election show Chancellor Merkel’s CDU/CSU gaining a strong endorsement from German voters, collecting almost 42 per cent of the vote, the best result since Helmut Kohl’s post-reunification victory in 1990.

However, the CDU/CSU didn’t win enough seats to form a parliamentary majority.

Furthermore, with her current coalition partner, the Free Democratic Party, failing to win any seats in the Bundestag (lower house), Merkel now needs to find another ally to form a stable government.

The most likely outcome is the so-called grand coalition: an alliance of the CDU/CSU with the centre-left SPD. This would deliver a majority in both houses, aiding legislative change. Without the SPD, Merkel faces the risk of serial gridlocks trying to get legislation passed through the left-dominated Bundersrat (upper house).

Of course, SPD leaders will be aware that Merkel’s last two junior partners suffered big drops in their electoral support after their coalitions and will want incentives for taking the political risk of forming another alliance with the CDU/CSU.

While it’s clear that Merkel has the upper hand, negotiations are still likely to run for several weeks. Other outcomes are possible but they are much less probable than the grand coalition.

The SPD has ruled out cooperation with the anti-capitalist Left and hence is very unlikely to enter a left-wing ‘red-redgreen’ coalition.

A CDU/CSU-Green coalition is plausible, but would require the Greens to exhibit considerably more willingness to compromise than shown during election campaigning.

Weighing up the outcomes, JP Morgan economists put the grand coalition at a 70 per cent probability, a CDU/CSU-coalition at 25 per cent and all other outcomes at a collective 5 per cent.

Under a grand coalition, we’d expect Merkel to grant concessions in the domestic policy areas that have been at the heart of the SPD’s social-justice oriented campaign.

The most likely sort of compromise would be for the grand coalition to implement the SPD’s proposed minimum wage and some of their other domestically-orientated policies in areas such as healthcare.

Merkel looks less likely to grant concessions on the European policy front. Indeed in Monday’s press conference she declared “our European policy will not change”.

Furthermore, the SPD backed Merkel during bailout votes in her second term and has not focused on eurozone policy in its election campaign in a way that would suggest it is about to demand a change of direction.

So, from a broader eurozone perspective, the German election does not look like it is going to change the course of key policies.

While the new German government might be marginally more growth-friendly than its predecessor, it is likely to retain Merkel’s resistance to debt mutualisation and her general gradualist stance on political integration. For example, there is little reason to expect that Germany will want to speed-up the eurozone’s hesitant progress towards banking union.

The first test of the new government’s policy stance might well come from negotiations surrounding new bailouts for Greece and Portugal in the next few months.

At this stage it’s hard to evaluate the extent to which these events might rekindle systemic tensions in the region. Confidence in the economic recovery will probably play a big part in shaping investor attitudes. Markets will be considerably more tolerant if bailout negotiations take place against the backdrop of a continued economic recovery.

Whatever happens in the German parliament, Europe still needs growth.

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