The ecstasy and the agony.
Angela Merkel scored a resounding election victory but by apparently falling just short of an overall majority, while her FDP coalition colleagues failed to get the 5 percent share of the vote needed for any parliamentary representation, she is probably going to have to turn to the centre-left SPD to form a government.
An SPD/Greens/left coalition is not impossible but having secured 42 percent of the vote, the tune is Merkel’s to call.
A grand CDU/SPD coalition is favoured by the German public, according to the polls, and could lead to some policy shifts, and certainly a lot of haggling over key positions in government (will Wolfgang Schaeuble remain as finance minister?) but is unlikely to lead to any seismic shifts, particularly in euro zone policy. The anti-euro Alternative for Germany (AfD) fell just short of 5 percent but having come from nowhere in just seven months, it has put down a marker.
All the parties will hold press conferences today so next steps could become clearer, although the first key meeting is probably an SPD convention on Friday. The euro got the smallest of upticks from the election result while German Bund futures have opened modestly higher with the assumption of policy continuity holding firm.
The history of the euro zone crisis shows that Merkel has had to tread very carefully to keep public opinion, the Bundestag and Germany’s powerful constitutional court on side and a government of whatever hue will face those same constraints. If she tried to rule alone, she would be prey to malcontents in her CDU and CSU sister party, while the centre-left has a strong grip on the upper house of parliament.
Elsewhere in the euro zone, policymakers will be looking for signs of greater flexibility from Berlin. The Constitutional Court is weighing the legality of the European Central Bank’s bond-buying programme, Greece (where the troika returned on Sunday for its latest review) and Portugal could need new bailouts, and the EU is working on a banking union that may bring new liabilities for German taxpayers. Let’s not even mention Italy.
The involvement of the SPD in government could see some movement at the margin on banking union although even before the election Merkel’s camp signalled it was looking for progress that did not require lengthy EU treaty change, and admitted that Greece would probably need a third bailout of some form.
Domestically, the SPD is in favour of a minimum wage and other new labour market regulations which could give investors pause for thought.
Perhaps the most sobering fact for the markets is that horse trading over the details of a coalition line-up and policy slate could take several weeks, even two months.
The SPD looks less amenable than it did during a 2005-2009 grand coalition and is scarred by the loss of support that experience cost it. Political history shows junior coalition partners often suffer disproportionately. Merkel herself said last night: “Maybe we won’t find anyone who wants to do anything with us”, while the SPD chairman said there was no automaticity about a deal.
Merkel could look to the Greens if the SPD won’t play ball though if anything there appears to be even greater policy differences between those two camps. But one thing is certain – Merkel remains the dominant EU leader and the one who will dominate the arena.
The Federal Reserve has thrown a curve ball by opting not to start winding back its stimulus programme. The big question for every other central bank in the world is to what extent it is possible to decouple from what the dominant member of the pack is doing.
ECB chief Mario Draghi testifies to a European Parliamentary committee and will presumably be grilled on his ability to convince markets that euro zone interest rates will not rise for a long time yet. The Bank of England has also struggled in that regard but at a stroke, the Fed’s inaction did the job for them … for now at least.
Flash euro zone, German and French PMIs will begin putting the final pieces in the third quarter economic jigsaw. The surveys have been strong through the last quarter, putting a question mark over gloomy European Central Bank and German government forecasts for the second half of the year.
The currency bloc as a whole looks set to pretty much replicate its 0.3 percent growth in the second quarter, nothing spectacular but a sign that recession is probably a thing of the past. China’s PMI, out earlier, showed factory activity growing at its fastest pace in six month. There is growing evidence that the Chinese economy’s growth slowdown could have bottomed out.