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ANALYSIS: Has German election killed the European spring?

A surprising lot of fund managers are intent on downplaying the significance of this election result, I found out when I opened my e-mail inbox this morning. They seem to take comfort from the election result having secured Chancellor Merkel another term in office, since her CDU remained the largest party by a big margin.

“This was always expected to be least exciting election night for a very long time. (…) This should not distract markets too much,” said John Taylor, manager of the Alliance Bernstein Global Diversified Yield Plus fund.

Wolfgang Bauer, a bond fund manager at M&G Investments and a German national, more correctly evaluated the election outcome, stressing that Merkel continuing as Chancellor and the CDU remaining the largest party are not the main take-aways from this election.

Instead, that’s the unprecedented loss of Germany’s governing coalition. The social-democrat SPD and Merkel’s CDU/CSU both recorded their worst election result since the 1940s.

“The CDU/CSU’s record loss of 8.5% of the voting share is all the more significant considering the strong economic backdrop, which should actually have been a tailwind for Merkel as the incumbent chancellor,” said Bauer.

Macron challenge

It’s clear that this was a Pyrrhic victory for Merkel, and that she is now severely weakened, putting her de facto leadership position in Europe into question.

“She might get challenged by French president Emmanuel Macron for the unofficial leadership role within the EU. If he is able to seize the moment, this would make eurozone debt mutualisation and the creation of a European finance minister more likely, at least in the medium term,” said Bauer.

Chancellor Merkel is now likely to play less of a prominent role on the EU stage, as she will be forced to spend a lot of energy on complicated coalition talks, keeping her part together and, as she put it on Sunday night, on “winning back the votes lost to the [far-right] AfD”.

Whether Mr Macron is now more likely to gain support for his plans is uncertain though. The liberal FDP, one of Merkel’s likely coalition partners, is a staunch opponent of further fiscal integration in the eurozone, and it sees the finance ministry as the biggest prize up for grabs in upcoming coalition talks. And if Merkel wants to heed her post-election promise to try and win back the more than one million voters who switched to the Eurosceptic, anti-immigrant AfD, it will be difficult for her to cede more sovereignty.

Populist revival

Germany’s biggest banks (Deutsche bank (-1.4%) and Commerzbank (-1.3%)) were among the worst performers on Frankfurt’s stock exchange on Monday, while the euro dropped to its lowest level against the dollar in a week. This all, quite logically, suggests financial markets believe the election outcome isn’t helping financial stability in the eurozone.

Another conclusion from Germany’s elections is that the rise of populism is still very much alive in Europe. “This could have implications for markets, which arguably have become somewhat complacent in this regard,” said Bauer. European equity markets and the euro have rocketed since Emmanuel Macron convincingly fended off a populist challenge in France’s presidential election, and peripheral bond yields have compressed.

If expectations that Macron’s victory would herald a sustained period of political calm and further economic integration in the eurozone are dashed further, these market movements may well reverse. And the outcome of the German elections have certainly increased the chances that the European spring will come to a premature end.

Part of the Bonhill Group.