A weakened Merkel leaves EU integration on the back-burner

Europe's politically supercharged year has ended with a jolt of excitement as Germans went to the polls on Sunday.

Dubbed a “sleep campaign” and all different shades of “boring” by the German media, it was widely expected that markets would react with a big fat “gahn” (German for yawn).

However, what we got was a stark reminder that the populist threat is a real one, as the Alternative fur Deutschland (AfD) party entered parliament with 12.6 per cent of the vote, making it the first far-right party to enter the German Bundestag since 1960.

This strong showing sent shockwaves through Germany’s political and business elite, and was widely seen as a backlash against Chancellor Angela Merkel’s “open door” refugee policy.

While Merkel will continue to govern for a fourth term, her party’s support fell to its lowest level since 1949, making the task of forming a coalition a much tougher one this time around. The euro fell slightly against the dollar overnight Sunday before, recovering some losses.

In another shock, the Social Democrats have announced that they will go into opposition, leaving only one coalition possible – the so-called Jamaica coalition (the Christian Democrat alliance of the CDU and CSU, along with the liberal FDP, and the Greens), so named because of the different party colours.

Let’s start with the good news. Domestically, all of the parties above are still committed to sound public finances of a balanced budget and “no new debt”. Equally, economists at UBS Wealth Management add that moderate income tax cuts (worth 0.5 to one per cent of GDP) seem likely, as all parties have included those in their manifestos.

But the tougher nut to crack will be the stance on Europe.

According to Barclays analysts on Monday morning: “a Jamaica coalition would likely make it more difficult to pursue further euro area reform. Making tough decisions with only a fragile 52.4 per cent majority is hard. The AfD result could move some CSU politicians towards a more hawkish stance on fiscal risk sharing. The Greens and FDP also have opposing views on EU policy.”

UBS Wealth Management explains that “working towards transforming the ESM (European stability mechanism) into a European Monetary Fund is a part of all the major parties’ manifestos, except for the FDP which wants to phase out the ESM lending capacity and is most opposed to further European burden-sharing.”

Interestingly enough, the liberal FDP had also been hoping to lay claim to the powerful Finance Ministry ahead of the election. If that scenario materialises, it means fewer bailouts for Europe.

A bland and predictable election has now turned into a possible turning point for Europe’s integration.

French President Emmanuel Macron’s vision of a deeply integrated Europe which he will present on Tuesday might fall on deaf ears – as long as those pesky coalition talks persist.

Even in highly efficient Germany, this will take months.

Full story: A weakened Merkel leaves EU integration on the back-burner: City A.M.