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German election: Merkel's coalition partners could shape EU relations

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Angela Merkel looks set for a fourth term as German chancellor in Sunday’s election, according to commentators, but question marks hang over which parties will make up the likely coalition and the subsequent implications for Franco-German plans for the EU.

Assuming no major surprises, one possibility is for Merkel’s CDU to form a “Jamaica” coalition with the FDP (the liberal democrats) and the Greens.

In the FDP, however, the CDU would have a coalition partner with a vision for Europe different to its own and that of Martin Schulz, the chancellor candidate for the SPD, according to Fabien de la Gastine, fixed income fund manager at La Française. The SPD has been the CDU’s partner in a so-called “grand” coalition since 2013.

Léon Cornelissen, chief economist at Robeco, said the FDP may prove to be the “dark horse”.

“The party currently has no seats in the 598-seat Bundestag but has over 10% support in the polls, which means it may hold the keys to power,” he said.

The FDP is a natural coalition partner for the CDU and a deal would be considered very business-friendly, Cornelissen added, but its “somewhat eurosceptic” stance on Europe could make a deal with French president Emmanuel Macron difficult.

“A particularly strong showing for the FDP would unsettle markets for a while, as it would also force Merkel to be not that generous with France,” he said. 

Economists at Bank of America Merrill Lynch agreed that the FDP’s potential inclusion in the German government would have a significant impact on Germany’s ability to support Macron’s – and European Commission president Jean-Claude Juncker’s – desire for more EU integration.

The bank’s analysts, meanwhile, noted that Merkel and Macron had previously spoken about harmonising corporate tax rates in Europe, and that such an initiative could take on greater importance if the US president delivers a sizeable corporate tax cut.

“The US will effectively ‘piggy back’ much of Europe in lowering its tax rate,” they said. “In fact, Germany’s corporate tax rate will begin to look relatively high. Over time, if Europe sees a drift down in some corporate tax rates, then we believe it will be a helpful tailwind for credit spreads.”

Much of the attention surrounding Germany’s election will be on the anti-immigrant, anti-euro AfD party. A poll today had it on course for 11% of votes, well above the 5% that is required to get a seat in the Bundestag. It would mark the first time a far-right party entered the German parliament since World War II.

The main parties have ruled out partnering with the AfD, however.

La Française’s de la Gastine said: “Without a strong negative surprise, consequences on German growth and financial markets should be limited. Over the longer term, a pro-Europe coalition could give a new momentum to the EU and strengthen the euro.”

Nadège Dufossé, head of asset allocation at Candriam Investors Group, said the longer-term impact of the result “should be market-friendly”.

“Unlike the polls in other major countries over the past 12 months, no major party is running a platform on exiting the EU, cutting the healthcare service or building a wall with its next-door (country) neighbour – in a nutshell, political risk should not rise as a result of the elections,” Dufossé said. “In the medium term, this is likely to prove supportive of European assets, including the euro.”

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