Eyes on Germany

Kerry Craig

With much of Europe back from summer holidays and the European economy seemingly gaining traction, investors have begun to focus on the federal election in Germany on 22 September. Given the country’s prominent role in European fiscal and political decisions, the composition of the German government will have a significant impact on the direction of domestic and pan-European policies going forward.

For example, the establishment of a fiscal union to complement the existing monetary union in Europe would be a positive development for the eurozone as a whole, and provide a solid backdrop for European equity markets in the future. However the implementation of this and other policies will be dependent on the composition of the elected government.

Although Angela Merkel’s Christian Democratic Union party and its sister party the Christian Social Union currently lead the polls, it does not appear that they will garner enough support to gain outright control of the Bundestag. As shown in the chart, Ms Merkel’s CDU-CSU party currently has 39 per cent of the vote, according to the polls, but this is 8 per cent to 9 per cent short of what is needed to secure an outright majority.

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Given that it does not seem the CDU-CSU will win outright, investors have begun to speculate about what a coalition government might look like. The two most likely outcomes are either a Christian Democrat/Free Democratic coalition or a Christian Democrat/Social Democratic coalition. The CDU/FDP coalition would be the most politically logical combination, and would allow the CDU to essentially have all the say, as FDP would be a relatively weak coalition partner. However the two parties might not agree on issues surrounding the euro and the possibility of a fiscal union. The most likely alternative is a CDU/SPD coalition, a combination that worked previously from 2005 to 2009 and one that would enjoy an absolute majority in the government. That said, it might be hard for the two parties to reach consensus on key social and economic topics, particularly given their philosophical differences.

While the coalition will most likely consist of one of the parings described above, the SPD candidate, Peer Steinbruck, was better than expected in last weekend’s TV debate. This has led to higher approval ratings and a rising probability that Ms Merkel will be unable to reprise the current CDU-CSU/FDP coalition. However, at the current juncture, it does not appear likely that the SPD would partner with other parties (that is, the Greens and the Left Party), but this possibility should not be completely discounted. There is an outside chance that we could see a coalition similar to this try and take control of the Bundestag, but a government of this composition would call into question a number of assumptions concerning Germany’s approach to domestic and regional issues. This would likely result in elevated market volatility and a preference for less-risky assets as investors try and evaluate the future direction of German policy. Thus, while our base case still favours a CDU-CSU/SPD coalition over a coalition of smaller parties, it is important for investors to recognise this is not a sure thing.