David Marsh: German Result May Slow Euro Area Reform

2017-10-16 IMI

This article first appeared in OMFIF The Bulletin in October 2017. David Marsh, Member of IMI International Committee, Managing Director of OMFIF Unprecedented three-way alliance likely to turn inward Germany’s 24 September election result has changed the political shape of Europe, with an impact already starting to show on financial markets. Chancellor Angela Merkel’s weakened authority, the impending departure of Wolfgang Schäuble, her veteran finance minister, and the fragmented nature of the next parliament will have widespread effects throughout the continent. Momentum towards genuine reform in the euro area looks likely to slow, possibly to a trickle – epitomised by President Emmanuel Macron’s decision to tone down mention of a European finance ministry, euro area budget or supranational debt-issuance from his Paris speech on 26 September. Macron is showing good judgement by not – for the moment at least – provoking the Germans into any reaction with proposals that would be unpalatable for two smaller parties with sceptical views on the euro that proved to be the German election’s sole beneficiaries. Uncomfortable three-way alliance The most probable outcome of talks on forming a new administration remains an uncomfortable three-way alliance between Merkel’s conservative grouping, the Christian Democratic Union and Christian Social Union, the liberal Free Democratic Party and the Green ecology party. An important force for caution over euro area reform will stem from the FDP, with 10.7% of the votes, up 5.9 percentage points from the election in 2013. A minority government or even new elections cannot be ruled out. There is an outside chance, too, that, if arduous coalition-building runs into a dead end, Germany may even see a repeat of the unpopular ‘grand coalition’ between the CDU/CSU and the Social Democrats, the two main German parties, which both slumped on 24 September. However the chances are relatively good for the first three-party federal coalition in the post-war republic’s history, the so-called Jamaica coalition. Such an alliance has been formed at a regional level, notably in the current government of Schleswig-Holstein. The other principal euro area hindrance will be the anti-euro, anti-immigration Alternative for Germany (AfD), the first far-right party to enter the Bundestag since the 1950s, which took 12.6% of the vote, up 7.9 percentage points from four years ago. The AfD will not be part of any coalition. Yet the radical-right party is the new ‘third force’ in German politics after the two mainstream parties, Merkel’s conservative alliance and the SPD. These two parties suffered a decline in voting share to 32.9% and 20.5% respectively, the lowest since 1949 for the CDU/CSU, and, for the SPD, the lowest in any federal election since the second world war. The AfD’s powerful if cacophonic media presence and its significant participation in the swollen 709-seat parliament with 94 seats (against 246 for Merkel’s CDU/CSU, 153 for the SPD and 80 for the FDP) will toughen considerably the political debate on the euro. This makes German concessions towards French plans for a significant euro area budget less feasible. Swing to euroscepticism Germany’s political energies are visibly turning inwards. Partly in view of the fragmented nature of the new Bundestag, Merkel is dispatching Schäuble to become the parliamentary ‘speaker’ (president), where he will take up his duties at the end of October, before formation of the new coalition. This is part of an effort to ensure that a polarised legislative body will not become unduly fractious. The top post in the finance ministry will go to a far less authoritative and less well-known figure in the yet-to-be formed Berlin coalition. One of the front-runners is Wolfgang Kubicki, a veteran FDP politician who plays a major role in Schleswig-Holstein. Kubicki has declared his interest in the finance ministry job and would bring considerable expertise in the field of tax simplification – one of the areas which the FDP wishes to emphasise. The general swing towards euroscepticism could affect a decision on quantitative easing at the next European Central Bank council meeting on 26 October. The central bank is due to extend QE purchases next year, yet at a lower rate, both because it is running out of eligible bonds to buy and because earlier deflation fears have virtually disappeared. The council almost certainly will not formally decide an end-date for bond purchases, reflecting fears that – in view of German hostility – it will not be able to restart a programme once it is ended. In famous remarks in April 2016, unintended for public consumption, Schäuble attributed half the blame for the AfD’s surge on ECB President Mario Draghi’s easing policies. These have reduced interest rates for German savers, increased disparities between richer and poorer Germans, and fuelled anxieties over an eventual inflation surge. This uncertainty over the political environment will add to market nervousness before the October ECB meeting.

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David Marsh: German Result May Slow Euro Area Reform

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