Markets muted after German poll

But the probable outcome of a CDU/CSU grand coalition with the SPD may bring a long-term shift

GERMANY has voted, and despite Angela Merkel’s triumphant showing, a “grand coalition” between her Christian Democrat alliance (CDU/CSU) and the Social Democratic Party (SPD) has emerged as the most likely outcome.

Euro-dollar initially rose to $1.3546 in early trading yesterday, before dropping below $1.3480 in the afternoon. But as a recent note by JP Morgan pointed out, volatile currency movements either side of Eurozone elections are the norm (see table). And as Ashraf Laidi of City Index also notes, “the more dynamic forces of continued Eurozone data improvement and continued US quantitative easing (after last week’s non-taper) are seen as the dominant forex factors in the immediate future.” The result of these elections has long been seen as a foregone conclusion, with Merkel always likely to remain Chancellor.

But while market reaction has been muted, a grand coalition may affect both the direction of the German economy and (by implication) the Eurozone more generally. A number of traders and analysts see the prospect of including the left-leaning SPD in the German government as significant – both for the internal make-up of the German economy, and Europe’s banking system.

NEW DOMESTIC PRIORITIES
“Germany’s economic discourse is undergoing an important shift,” says Berenberg’s Christian Schulz. “Whereas the focus was previously on generating growth, German politicians are increasingly concerned about the distribution of income – and the involvement of the SPD in government is likely to accelerate this trend.”

The SPD manifesto called for a minimum hourly wage of €8.50 (£7.15), amounting to 53 per cent of the average wage and affecting around 6.1m jobs (roughly 19 per cent of employment, according to Morgan Stanley). Anatoli Annenkov of Societe Generale says that “the SPD will likely come to the coalition negotiations with more demands, and this may shift the debate towards redistribution.”

If Germany does begin to “turn inwards”, as Schulz puts it, and focuses more on redistribution and increased domestic demand, some argue that this may be positive for other Eurozone countries in the short term. “The space vacated by German exporters on the margin may be taken up by firms in France, Spain, and other peripheral economies in this scenario,” says Ishaq Siddiqi of ETX Capital. Siddiqi tips industrial equities in these countries, as well as the bonds of peripheral economies if such a recovery arises. “The Spanish clothing maker Inditex also looks particularly attractive if Spain’s share of exports grows,” he says.

But this viewpoint is open to criticism. First, the idea that the Eurozone’s continued problems can be solely attributed to weak domestic demand in Germany is dubious, with a lack of progress on reform in many peripheral economies equally worrying. An analyst at Dawia Capital pointed out in a recent note that the rating agency S&P has placed Portugal on a negative watch due to “potential shortfalls in meeting program targets that could increase uncertainty about the trajectory of government debt.” Other Eurozone countries have been similarly sluggish in enacting reform.

Secondly, on top of damaging green energy policies (costs associated with Germany’s renewable energy levy are expected to jump this year from €14.1bn to €20.4bn), many worry that SDP-influenced policies will harm the German economy. “Europe benefits from Germany’s strong economic leadership. While peripheral economies may benefit in the short term from increased domestic demand in Germany, emerging markets such as China and India will take up far more of the slack in the coming years,” says Schulz.

Moreover, “there is a possibility that the influence of the SPD may lead to other sub-optimal economic policies,” says Annenkov. Banking is particularly vulnerable. Analysts at Schroders “expect the next government to take a tougher stance towards banks and investors in banks (both equity and debt investors).” The SPD has publicly stated its support of a financial transactions tax (FTT) in Europe, and the possibility of banking levies would not bode well for Germany or Europe’s banks. Deutsche Bank shares (Germany biggest bank) fell from around €35.80 to around €35.14 in the early evening yesterday.

WITHIN EUROPE
Beyond the implications for Germany’s banks, however, some see a grand coalition as potentially significant for Europe more widely. The OECD recently warned that “Euro area banks are insufficiently capitalised and weighed down by bad loans.” But according to Azad Zangana of Schroders, “the big risk is that, against a backdrop of a more hostile stance towards banks in Germany, the European Central Bank presses for an accelerated recapitalisation process, leading to banks cutting back lending in the absence of the ability to raise capital.” The scenario could have difficult implications for several economies. Bank lending in the Eurozone was already down 1.9 per cent in the year to July.

Beyond banking, however, most see little scope for change on the future of key Eurozone debates. “A Germany led by a grand coalition may be slightly more likely to pursue a growth (rather than austerity) agenda in Europe,” says Schulz, “but the difference is fairly marginal.” The SPD are widely seen as less focused on austerity in the periphery, with their leader Peer Steinbruck recently stating that it makes no sense to apply a “deadly dose” to the struggling countries of the Eurozone. But Annenkov says that the high share of the vote that Merkel achieved, along with the strong showing of the anti-euro AfD, implies a mandate on Europe the SPD may not challenge.