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Political risk in Europe has fallen

Contributors Michael Bell, Vincent Juvyns, Tilmann Galler, Maria Paola Toschi
In brief

2017 was billed as a year of potential political turmoil for the eurozone. Investors feared that elections in the Netherlands, France and Germany could lead to a victory for an anti-euro party plunging the very future of the eurozone into doubt. Instead, political risk has so far proved to be all bark and no bite, with voters in both the Netherlands and France following the Austrians in rejecting populist anti-euro candidates. The risk of an anti-euro victory in Germany in September is negligible. The biggest risk to the euro remains Italy, where popular support for the euro is much lower than elsewhere in Europe. Even in Italy though, a referendum on euro membership, is not the most likely outcome following the election. In the UK, the Conservative Party look likely to increase their majority but the outcome of the Brexit negotiations remains highly uncertain although continued single market membership remains very unlikely.

Germany – federal election in September – risk to euro extremely low

What is happening?

The year started so well for Martin Schulz and the Social Democrats (SPD). After he had secured the candidacy in a surprise upset, the Social Democrats surged an unprecedented 10% in the polls transforming an apparently boring re-election bid by Angela Merkel into a tight race. Two weeks later, in mid-February, the SPD inflicted a defeat on Angela Merkels’s Christian Democrats (CDU), securing the presidency for Frank-Walter Steinmeier. The German president has only symbolic duties, but the election was significant since it marked the first time that the CDU was unable to nominate a candidate.

Since then, however, the pendulum has swung back in favour of Chancellor Angela Merkel’s CDU, with three successive disappointments for the SPD in state elections. In Saarland, Schleswig-Holstein and North Rhine-Westphalia (NRW) the CDU secured the necessary majority to appoint the next state prime minister. The recent defeat in NRW, the most populous state in Germany, was particularly painful for the Social Democrats, given that the state is traditionally viewed as SPD-heartland. The swing in electoral support from the centre-left to the centre-right since 2012 makes it once again possible to imagine a coalition between the CDU and the free market Free Democratic Party (FDP) after the federal election on September 24.

Exhibit 1: gain and loss in popular vote in % vs. 2012 state elections

Source: www.wahlrecht.de, J.P. Morgan Asset Management data as of 18 May 2017. *NRW= North Rhine Westphalia, S-H= Schleswig-Holstein, Saar= Saarland.

Exhibit 2: latest polls on German voting intentions

Source: Forsa, J.P. Morgan Asset Management; data as of 18 May 2017.

Though the betting now favours Angela Merkel, her re-election as Chancellor is not a done deal, for three reasons. First, because state elections scheduled before the federal election are somewhat influenced by federal politics but they are still dominated by local politics and issues. Second, the 2005 campaign between Chancellor Schröder (SPD) and Merkel (CDU) shows that even a healthy margin in the polls can erode very quickly. Schröder’s SPD trailed the CDU by almost 20% after the surprising defeat in NRW, but was able to close the gap to only 1% on election day. As of today Martin Schulz is trailing Angela Merkel by 12%. Based on the current polls, the following coalition governments are possible:

  • Grand coalition (CDU/SPD) currently with 64% of popular vote; Chancellor Angela Merkel
  • “Jamaica coalition” (CDU/FDP /Green) currently with 53% of popular vote; Chancellor Angela Merkel
  • Center-right coalition (CDU/FDP) currently with 46% of popular vote; Chancellor Angela Merkel
  • Red-Red-Green (SPD/Linke/Green) currently with 41% of popular vote; Chancellor Martin Schulz

No other combination is currently likely, since all parties rule out a coalition with the right wing populist party Alternative für Deutschland (AfD). The eurosceptic and anti-immigration party AfD managed in all three of the recent state elections to jump over the 5% popular vote threshold to enter into the local parliaments for the first time, but the gains were much smaller than initially expected. The left populist party Die Linke failed to clear the 5% threshold in two state of the three state elections. On the face of it, the declining refugee crisis and the strong state of the economy have weakened the appetite for radical change among German voters.

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