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The German Election: What You Need to Know

Posted on: 20 September 2017 , by: Darren Sinden , category: Market Review

The German Election: What you need to know

On September 24, Germany will go to the polls to elect a new government.

Voters will have to decide whether to give Chancellor Angela Merkel a 4th term, allowing her to follow in the footsteps of her predecessors, Helmut Kohl and Konrad Adenauer, each of whom served five terms as Chancellor. Alternatively, voters may choose to back the opposition candidate Martin Schulz, the leader of the Social Democratic Party and former president of the European Parliament.

Coalition and consensus

German voters will also elect local representatives in their 299 districts or constituencies. Voters then cast a second vote for the party of their choice. Another 299 seats in parliament are then awarded proportionality, based on that second vote. These secondary votes are often decisive in determining the composition of the Bundestag. The hybrid system typically gives rise to a coalition government, as no one party will have an outright mandate.

The likelihood is that Angela Merkel will be returned to power as she has a clear lead in the polls. For the last 12 years, the German Chancellor has ruled by consensus in a so-called “grand coalition” between her CDU party, its allies the CSU, and the Social Democrats (SPD). 

Still, could there be changes ahead? 

However, many German political commentators are suggesting that there will be a change in the composition of that coalition. As parties such as the conservative FDP and the right-wing Alternative for Germany (or AFD) are thought to likely have a bigger say in the new parliament. Should that be the result, then we will probably see a tougher stance from the new administration, particularly on issues such as Greece and further bailouts therein. Before the election, all parties have ruled out forming a coalition with AFD further complicating the post-election picture.

The AFD believes that Greece should exit the Euro for example, rather than be bailed out once more. There could also be a tougher stance towards Turkey. Of course, German Turkish relations have become increasingly fractious since the failed coup in Turkey and President Erdogan's subsequent clampdown. Polls suggest that the AFD will win between 8-9% of the vote. But the coalition and proportional representation systems could allow them to punch above their weight and leverage their seats - in a similar way to the Ulster Unionists in the UK Parliament. Notwithstanding the other party's pre-election pledge. The renewed appeal of the right wing could also mean that FDP shifts its stance in that direction, to attract and retain voters.

The campaign is hotting up

Campaigning gained momentum last weekend (3/9/17) with a televised debate, which pitted Mrs Merkel and Mr Schulz against each other. Mrs Merkel was seen to be the clear winner, but Mr Schulz gave a much better account than many voters had expected. He landed blows on Mrs Merkel, as he accused the Chancellor of being too soft on, and too closely aligned with, the major automotive manufacturers who are, of course, being investigated by German authorities over alleged collusion in the diesel emissions scandal.

For his part, Mr Schulz is a social progressive who favours free education and healthcare. He is keen to close what he describes as the intolerable pay gap between men and women in the country. He also believes in a Europe-wide approach to the refugee crisis and has campaigned for the removal of US nuclear weapons from German soil.

Key issues for Germany

Immigration in Germany is a critical issue because of the poor demographics in the country, which has the second oldest population in the world after Japan. There are several issues to consider here: Firstly an ageing and reducing workforce will be less productive, and ultimately dependency ratios, that is, the number of younger workers per elderly citizen will fall away. Implying much higher tax burdens for those younger workers. Of course as the population ages, the elderly become an increasingly important subset of the electorate. I note that approximately one-third of German citizens are 60 years of age or older. As such, issues like tax, benefits and pensions will be hotly debated topics in the election run-up. The beneficial effects of immigration have been to push Germany's falling birth rates to a 33 year high, though significant challenges around social cohesion remain and need addressing.

Predicting the result

Opinion polls have had a patchy record as far as predicting election outcomes over the last year or so. Analysts at Swiss investment bank UBS expect volatility in German polling in the run-up to the vote. They assign a 75% chance of Mrs Merkel being re-elected and would look for closer ties to Europe if the SPD forms a working coalition with the CDU. Germany and France are then likely to get behind Emmanuelle Macarons plans for integration and common tax policies under  those circumstances. 

However, the fiscally conservative FDP may not be so keen on tax harmonisation and other integration measures. As we have seen recently in France, winning the election is only half the battle. Forming a government and pursuing a reform agenda can be a much harder task. And it seems likely that there will be a good deal of political wrangling post the election. Particularly over key ministries such as finance.

As far as the markets are concerned a resumption of the status quo. Or even, a bigger say for the FDP in a new coalition, would likely be seen as positive for the Euro. Though, of course, as we have previously noted, further prolonged Euro strength would push Eurozone inflation even further away from the ECB's 2% target. And, at the same time, potentially undermine Germany's export-led recovery, which has been the main economic engine of the Eurozone as a whole. 

I note that a 10% rise in the value of the Euro results in a -30 bp fall in Eurozone HICP inflation, according to research from economists at Société Générale.

The election result that the markets would least like to see would be a coalition between the SPD [a.k.a. SDP] and the Green Party.  That's because they would be likely to increase government spending, without necessarily raising money elsewhere. Fiscal discipline has after all been the cornerstone of German politics over much of the last 17 years. That left-leaning coalition is, however, also seen as being the least likely outcome, as the Greens have been losing ground of late. 

What will this mean for traders?

The relationship between the single currency and perceptions about German (wider European) economic performance can be seen in the chart below, that plots the Germany 30 equity index against the EUR USD Forex pair.

German DAX Index

As the Euro rises, German exports become more expensive to foreign currency buyers. That equates to lower sales and reduced earnings for German corporates (at least in the minds of traders). And, in turn, to a fall in the value of the Germany 30 equity index.

The ECB themselves do not want to see the Euro continuing to strengthen unrestrained. But, over the year to date, they have been largely ineffective in capping its rise. The return of broad coalition led by Angela Merkel would be positive for the Euro. Its composition may have some spending and tax implications for German domestic markets, and of course, as we noted, Mr Schulz could well press for tougher action against the Auto manufacturers who account for around 13% of the Germany 30 index, when measured by market cap.

Mario Draghi's tenure as ECB president is up in 2018, and the new German administration will be keen to see a German-centric candidate replace him. To avoid a situation where ECB policy and action is directly contrary to German interests. What happens next Sunday could well set the agenda, not only for Germany, but for Europe as whole, for the next four or five years. The lives of hundreds of millions of citizens and the economies they support will all be affected, one way or another. 
Major changes probably won't happen overnight but remember that the markets are forward looking. They will be pricing instruments to reflect the likely landscape, three to six months ahead. As a result of which, the last three months of 2017 promises to be a very interesting time for traders indeed.

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