Coalition wrangling in Berlin could hit economy

It’s not just UK politics that could impact Europe. Germany’s political uncertainty could weigh heavily on economic recovery

For corporate treasurers contemplating 2018, Germany and the euro area offer a study illustrating how apparently optimal developments could come unstuck. The booming German economy has been effectively decoupled from the political confusion in Berlin over forming a new government after last September’s inconclusive elections. Yet a big reason for buoyancy is a policy many Germans hotly oppose – the quantitative easing (QE) of the European Central Bank, inaugurated three years ago with a massive programme of bond-buying that could before too long prove destabilising for Europe’s largest economy.

Bundesbank president Jens Weidmann, a foremost critic of the potentially inflationary effects of QE, says the heady growth rate – 2.6% last year with 2.5% forecast for 2018, driven by external demand boosting domestic investment and consumption – will decline thereafter because of capacity problems and labour shortages.

Weidmann’s prognosis points to the need for measures to increase Germany’s underlying growth rate. But firm policy action will be lacking unless a new government is formed soon with economic policy strength.

Lack of progress in Germany is creating dissatisfaction in France. President Emmanuel Macron is waiting for reactions to his plans for reinforcing the structure of economic and monetary union. Macron’s plans could cost considerable sums for Germany’s economy, but would shore up its long-term export base in Europe.

Chancellor Angela Merkel’s centre-right Christian Democratic Union (CDU)/Christian Social Union (CSU) grouping and Martin Schulz’s Social Democratic Party are battling to forge a new variation of the ‘grand coalition’ in force since 2013. Coalition soundings started with cautiously optimistic statements on both sides, following the breakdown of negotiations in November on an ambitious alliance between the CDU/CSU, the liberal Free Democrats and the Greens ecology party.

Formal negotiations now under way could lead to formation of a government by early April. However, in view of party differences over finance, Europe, energy, migration and social security, the next stage of coalition building could easily break down.

All putative coalition partners are combating internal wrangling, leadership doubts and electoral challenges from the far-right Alternative for Germany (AfD). A reforging of the CDU/CSU-SPD coalition would make the AfD – the first far-right party in the Bundestag since the early 1950s – Germany’s formal political opposition, adding to its range and influence.

If coalition talks stumble, this could confront Germany either with an unstable Merkel-led minority government, or new elections in early summer for which the CDU/CSU could replace Merkel as leader. Opinion polls put German electoral support for a new CDU/CSU-SPD alliance at a mere 52%.

Britain’s EU withdrawal is contributing to uncertainty. Leading Germans believe that, with the UK outside, Germany will come more under the thrall of France and other ‘southern’ countries. This could bring increased state intervention, protectionism, criticism of Germany’s monetary and financial leanings, and channelling German surpluses and savings into expansionary European policies. This might sound like good economic news for Europe – but the political backlash from a strong, yet increasingly polarised Germany could weaken the continent and snuff out recovery. Much is at stake – and much is unresolved.

David Marsh is chairman of the Official Monetary and Financial Institutions Forum

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