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With the outcome of the German federal election seen as a near certainty, investors are more focused on what the likely re-election of Angela Merkel will mean for European integration, says Geoffroy Lenoir.

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While the UK’s referendum on European Union membership and the election of Donald Trump as US president highlight that pollsters and bookmakers can be wrong, it seems almost certain that Angela Merkel’s Christian Democrats (CDU) will again emerge as the largest party in Germany following federal elections on 24 September. 

The main issue is whether Germany’s other major party, the centre-left Social Democrats (SPD), can gain enough support to re-enter a grand coalition with the CDU. Such an outcome would be positive for further European integration, as Geoffroy Lenoir, Head of Euro Sovereign Rates, explains in this Q&A. 

What are the key issues at stake in the German election?

European integration is a critical concern for investors and the composition of the coalition formed after the election will be a key influence on this. A continuation of the grand coalition between the centre-right union parties of the CDU and Christian Social Union (CSU), and the centre-left SPD would be highly supportive for the EU. Such a coalition would be best placed to respond to President Macron’s proposal around a common EU budget and the creation of an EU finance department with its own minister. There could also be further developments in terms of military cooperation.

Fiscal reform is the other key issue. Major tax reforms aimed at reducing the burden on individuals and possibly companies can be expected if the grand coalition is re-established. Germany in general and the government in particular has also been slow in adopting to the digital world so new initiatives can be expected in that area, while immigration policy may also change after the election. 

Are there any particular concerns from an investment perspective?

A coalition involving the CDU-CSU, Free Democratic Party (FDP) and the Green Party could prove less supportive for financial markets than a grand coalition. It could take longer to form and would likely prove less cohesive in pushing through reforms: the FDP, for example, is staunchly opposed to more financial transfers between EU members. But this is certainly not a major concern for investors. Mrs. Merkel will almost certainly remain the chancellor and the overall direction of government policy will be unchanged.

If the Christian Democrats do need the support of those smaller parties, will that have policy implications for sectors such as autos and coal?

Even if Mrs. Merkel ends up having to form a coalition with the FDP and the Greens, it is unlikely the latter parties would have a major impact on policy should they enter government. Mrs. Merkel has already taken the lead on environmental issues; witness the drive to phase out nuclear power in Germany following the 2011 Fukushima nuclear disaster in Japan. The Green’s impact on autos is also unlikely to be significant given the sector is already on a clear trajectory towards electric vehicles, while the government is tackling 'diesel-gate'. 

In the unlikely event that a left-of-centre coalition led by the SPD takes power, what are the likely implications for investors? 

Mr. Schulz, the leader of the SPD, is even more pro-European than Mrs. Merkel, while there are unlikely to be any changes in economic policy. 

The CDU has pledged to increase defence spending after the election to two per cent of GDP, making it the biggest military spender in Europe. Which companies are likely to benefit the most? Would there be any impact on Germany’s foreign policy?

Higher German government spending should clearly prove supportive for companies in the European defence sector. I don’t think there would be much impact on German foreign policy given foreign deployments are tightly restricted by German law and parliament. There is no appetite in Germany for greater use of the military abroad.

Is the election likely to have any impact on bunds? Could yields go higher if Merkel gains a comfortable victory or is the European Central Bank’s monetary policy the overriding influence?

The election is not viewed as a major event for the market, so prices are not going to move significantly. In the immediate aftermath of the vote, bund yields could fall marginally should the SPD fail to gain enough support to enter coalition talks with the CDU, while they could see a small 'risk-on' rise should a grand coalition seem the most likely outcome. 

Longer term, the formation of a grand coalition would be seen as supportive for Europe and could pave the way for a less accommodative monetary policy stance by the ECB. The market would likely focus on the positive economic numbers coming out of the euro zone and away from political risk. That could trigger a rise in bund yields over the coming quarters. Bunds would likely sell off slightly less, should the CDU-CSU form a coalition with other parties given the ECB would still be likely to alter its monetary stance, but political risk would be slightly higher. 

Important Information

Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at 18 September 2017. This commentary is not an investment recommendation and should not be viewed as such. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to future returns. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.

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