The German elections and the markets

Reichstag

Earlier this year markets were stalked by talk of political risk in the Eurozone. The euro itself was on trial in the Dutch and French elections. Like many in the markets we thought the euro would win, and European shares would rise to reflect the quickening pace of economic recovery in the zone. So it came to pass.

Today markets remain sanguine about European political risks, and assured that the economic recovery is now well set. In particular a majority of investors look forward to Mrs Merkel winning her fourth election in a row and continuing as Chancellor. They know what they get with Mrs Merkel and seem to like her approach to prudent management and budgetary control.

The latest opinion polls from Germany do confirm that Mrs Merkel should emerge as the leader of the largest party, with the best chance of being Chancellor. However, they also show that her party is some 5% lower in the polls than in the last General Election in 2013, which means it could lose a substantial number of seats. The polls also show a smaller fall in support for the main challenger party and current coalition partner, the SPD. They too would lose a few seats on this forecast.

According to the polling the Free Democrats and the AFD have picked up in the polls and will qualify for seats in the new Parliament, where they had none before because they fell below the 5% qualification threshold in the popular vote. The AFD are against the euro and Mrs Merkel’s migration policies and would not be wanted in a Merkel led coalition. The Free Democrats are her old coalition partners.

This may complicate the creation of a coalition and will leave Mrs Merkel in need of more compromises with others to construct a government. Most commentators do not think Die Linke, the Greens and the SPD will have enough seats to form a coalition without Mrs Merkel, but the arithmetic needs watching.

There are also problems in Spain. The Madrid government is seeking to arrest the elected political leaders in Catalonia, and to ban the referendum they have planned for October 1st on Catalan independence. The Spanish state asserts its right to remain a unitary state and the Madrid government is directly intervening in the devolved government of one of its richest contributing regions. These tensions are not helpful as Spain continues with her rebuilding of the banking system and her economic recovery.

We also await the Italian election. There again regional independence movements and the Five Star party will put the Euro on the ballot paper. Five Star are often the most popular minority party in the polls, but markets assume there will be some pro Euro coalition formed after the election. It could prove a lively contest, with fears in markets about its outcome. On current polls it looks as if the euro will once again survive a political test.

We remain in line with the general view in markets that political risk is not going to derail the economic recovery or the generally positive view of markets about Euro area shares. It is however important to understand that there remain tensions within the zone, and issues to resolve with the UK as it withdraws and takes away its budget contributions.

 


The above article was first published by Charles Stanley on 22nd September 2017