European election series: Part 2 of 4

Editor’s note: This is the second in the blog series about the forthcoming European elections. Follow the series and watch for the next post that discusses the political outlook for Italy.

German elections – a change in the political landscape?

Angela Merkel’s steadfast grip over Germany could be loosening. In September, Germany holds its general elections. But, unlike last week’s Dutch elections where the populist Freedom Party (PVV) provided mainstream parties a run for their money by placing second, in Germany it isn’t the Populist Party that is a threat to Chancellor Merkel. Rather, Martin Schulz, a newcomer to the race (albeit, in a mainstream party) could be the one contender to nudge Merkel from her post, with interesting implications for Germany and the European Union (EU).

Since the 1950s, the power in the Bundestag (the German parliament) has generally remained in the hands of the center-right Christian Democratic Union (CDU/CSU) and/or the center-left Social Democratic Party (SPD). At the most recent federal election, in 2013, the CDU/CSU union gained the most votes for the third consecutive time, with the SPD coming in second. The Eurosceptic Alternative for Germany (AfD), a populist party whose key positions are anti-immigration, anti-Islam, and anti-euro (but not necessarily anti-EU), was only founded in 2013 and its support failed to surpass the 5% threshold for securing seats in the Bundestag at that election.

Since then, AfD’s support has strengthened. The intensification of the refugee crisis in Germany in 2015 enabled it to triple its support from around 5% to around 10-15% by the end of last year, and it is likely to secure seats in the Bundestag in September.

But AfD’s support has since flat-lined and, at these levels, it is not going to disrupt the mainstream parties. What’s more, in a parallel to PVV in the Netherlands, AfD is unlikely to form part of the government. As a result of its extreme views the potential reputational damage of being associated with AfD has prompted all other parties to state their unwillingness to enter a coalition with it. So, despite it being Germany’s third most popular party, it is fairly safe to say that a populist party will not be able to participate in the next German government. Yet, while it poses limited political risk, AfD does indirectly influence government policy. Recently, Merkel has taken a tougher line dealing with the refugee crisis in order to fend off AfD’s growing threat.

Enter Martin Schulz, SPD Leader

Until a few weeks ago, Angela Merkel looked a shoo-in for Chancellor once again and a government coalition without CDU/CSU was almost unfathomable. But the recent appointment of Martin Schulz, ex-President of the European Parliament, as new leader of the SPD party has turned the election on its head. Schulz has a stronger approval rating than the previous SPD leader. Most importantly, he is more popular than Angela Merkel: in a recent poll, 50% of Germans said they would vote for Schulz as Chancellor compared to just 34% for Merkel.

Since Schulz’s appointment in late January, SPD has enjoyed a boost of around 10% in the polls, putting it neck and neck with CDU/CSU or even slightly ahead. Current polls also suggest that SPD could create a coalition with the Green and Left parties, meaning that a government without CDU/CSU may even be possible – a very significant event in German politics.

An EU friendly outcome

The EU is facing some serious challenges, particularly on the world stage. Brexit has made the European project more vulnerable than, perhaps, ever before. The EU’s relationship with the new U.S. administration is decidedly fragile, while its relationship with Russia is one based on rivalry and distrust. In this environment, Merkel’s departure would be a major loss. But Martin Schulz could be considered a reasonable replacement.

He has a strong commitment to European integration and supports the idea of an economic, financial, fiscal, and political union. He has a greater willingness for risk sharing via a European deposit scheme and even a euro area fiscal stabilization fund. In line with this, Schulz has been outspoken in calling for more flexibility in the EU’s treatment towards Greece and so would be welcomed by the peripheries. On the other hand, the UK could be a key loser from a Schulz leadership as he is more forthright than Merkel when it comes to the four cornerstones of the EU (free movement of labor, capital, goods, and services). With his over 20 years of experience in the European Parliament, Schulz is well-known in European politics – but he still lacks the geo-political experience of Merkel.

Change isn’t always bad

This year’s European elections are considered a key risk for markets. We would argue that investors should be calm about the German election. The Populist Party, AfD is not a threat, while the main contender to Merkel’s leadership is a staunch supporter of EU cohesion. Of course, it could be the novelty factor that is boosting Schulz’s popularity and much can happen between now and the September election – the official campaign is yet to even begin.

Security and Europe are likely to take center stage. A flare up of the refugee crisis would likely increase support for the AfD, but Merkel and Schulz currently take a moderately hard line and they would probably both respond by taking a tougher stance towards immigration. A re-intensification of Eurozone problems, perhaps due to problems in the periphery, could hand greater support to Merkel. By contrast, a growing nervousness about the survival of the EU – perhaps as a result of a populist victory in France – could benefit Schulz.

Merkel or Schulz? In a year of potentially dangerous election outcomes, that’s not a bad choice to have.

 

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