BERLIN Feb 1 (Reuters) - Chancellor Angela Merkel's conservative party faces the prospect of a heavy defeat in February in the first of seven regional elections this year that could reverberate in the capital and across Europe.
A series of scandals dogging her popular defence minister as well as Europe's sovereign debt crisis are two other sources of possible discomfort in February for Merkel, whose party has so far failed to reap any benefit from solid economic growth.
The German economy's strong performance at the start of 2011 follows an impressive growth rate of 3.6 percent in 2010 -- the fastest pace in two decades [ID:nLDE70A1OB]. The government then raised its 2011 forecast by half a percentage point to 2.3 percent while private economists expect growth of 2.5 percent.
Following are some of the factors to watch:
Merkel's Christian Democrats (CDU) could be swept from power in a Feb. 20 election in the city-state of Hamburg by the centre-left opposition Social Democrats and Greens party after ruling the prosperous northern port for the last 10 years.
Opinion polls in Hamburg showed the SPD far ahead with 43 percent (up from 34 percent in the last election in 2008) while the CDU slumped to 26 percent -- far below the 42.6 percent the CDU won in 2008.
A big defeat in Hamburg could rattle nerves in the CDU ahead of three more state elections in March, in particular in the conservative bastion of Baden-Wuerttemberg that the party has ruled for six decades. The CDU also faces defeat there, although recent polls show they have an improving chance of holding on.
Merkel's coalition lost control of the Bundesrat upper house of parliament after losing a regional election in May in North Rhine-Westphalia, meaning that left-wing opposition parties now block or interfere with much of her planned legislation.
Analysts warn losing more key states in quick succession, especially Baden-Wuerttemberg, would cause rumblings in the CDU rank and file. But it is unlikely Merkel would face any serious challenge to her leadership.
Merkel's conservatives are steady in national opinion polls at about 36 percent. But their coalition partners, the Free Democrats (FDP), are stuck at 3-4 percent from almost 15 percent in the 2009 election.
The opposition SPD are at about 27 percent and the Greens at 20 percent. The SPD got 23 percent in the 2009 election and the Greens were at 10.7 percent.
What to watch:
- Rumblings in the CDU about Merkel after an expected heavy defeat in Hamburg
- The FDP's weakness under Guido Westerwelle, foreign minister. It will remain a source of coalition tension. [ID:nLDE6BE1NX]
EUROPEAN DEBT CRISIS
The euro debt crisis also plays a role in state elections this year. Wary of a backlash from voters, Merkel has resisted calls in Europe to expand the 440-billion euro ($570 billion) European Financial Stability Facility (EFSF).
The FDP, facing a drubbing, is especially firm in its opposition to raising the size of the EFSF [ID:nLDE70P1KF].
But signs are emerging that Merkel is now trying to lead the debate. In a discussion paper obtained by Reuters, her office proposes a euro zone pact to improve competitiveness in exchange for German backing for any boost to the EFSF [ID:nLDE70R1XX]
What to watch:
- Merkel's public comments about the euro zone debt crisis and any change in fundamental reservations about raising EFSF.
Germany suffered its biggest postwar recession in 2009 when the economy contracted by 4.7 percent. Driven mainly by exports and helped by a pick-up in household consumption, it emerged from the slump. Business morale is currently at a record high and consumers' propensity to splash out money on big ticket items has not been this strong since December 2006.
As monetary and fiscal stimulus is gradually withdrawn from the global economy and some euro zone trading partners embark on strict austerity measures, Germany's red-hot export growth is expected to cool off and return to a more sustainable level.
Barring any major shocks from China, Germany should remain a one of the preeminent suppliers of high-quality capital goods to dynamic emerging markets looking to improve their infrastructure and boost productivity.
Many economists argue healthy corporate earnings and a tightening labour market will mean employers will have to raise wages to retain skilled workers. This should feed through into domestic consumption but could fuel inflationary pressures.
What to watch:
-- Whether demand for German goods among EU trading partners drops as a result of the sovereign debt crisis
-- Whether major export market China will throttle demand and to prevent its economy from overheating
-- If unemployment continues to fall, this should continue to support growth in consumer spending.
Bank bailouts, labour market subsidies and stimulus measures to boost growth have all added to Germany's debt burden.
Berlin estimates its total outstanding public debt rose to 82 percent of its overall economic activity, and Kiel-based think-tank IfW estimates it will grow to 84.3 percent of GDP in 2011 -- above the Maastricht criteria of 60 percent.
This year marks a turning point for Germany's state finances, as a new "debt brake" law comes into effect, forcing the federal government to reduce the gap between its annual revenue and spending to under 10 billion euros by 2016.
What to watch:
-- Auctions early in the year may still signal steady demand for Europe's benchmark debt, but the market could demand higher compensation in the coming months to offset inflationary risks.
-- Will Germany's plans for net new borrowing of 48.4 billion euros be revised substantially lower when the budget is reviewed in March? Originally it planned to issue on balance 80 billion more in debt last year only to reduce by nearly half.
For political risks to watch in other countries, please click on [ID:nEMEARISK] (Editing by Sonya Hepinstall)