Analysis: Guttenberg's fall leaves Merkel needing euro win

BERLIN/PARIS Wed Mar 2, 2011 10:35am EST

German Chancellor Angela Merkel makes a statement during a news conference in Berlin March 2, 2011. REUTERS/Thomas Peter

German Chancellor Angela Merkel makes a statement during a news conference in Berlin March 2, 2011.

Credit: Reuters/Thomas Peter

BERLIN/PARIS (Reuters) - The spectacular fall of her most popular cabinet minister leaves German Chancellor Angela Merkel badly in need of a win on the European stage but in a weaker position to help her euro zone partners.

Karl-Theodor zu Guttenberg, 39, stunned Merkel and German voters by resigning as defense minister on Tuesday over allegations he copied parts of his PhD thesis.

Stripped of his doctorate, the dashing Bavarian aristocrat, seen until recently as a future chancellor, also stepped down as a member of parliament, embarrassing Merkel who had defended him until the end.

The latest political setback may make it even less likely Germany, Europe's biggest economy, will agree to a domestically unpopular major strengthening of the euro zone financial rescue fund at a summit later this month, as markets are hoping.

If the outcome falls short of investors' expectations, it could trigger another run on euro zone peripheral countries' sovereign debt, traders say.

Guttenberg's fall was the second loss of a key Merkel ally in less than a month, after Bundesbank chief Axel Weber withdrew from the contest to head the European Central Bank, robbing her of a trump card in negotiations on reforming the euro zone.

"Things will be tougher for Merkel now than if Weber and Guttenberg had stayed," said European political analyst Janis Emmanuilidis, who is both German and Greek.

"On every issue where the impression is being created that Germans are going to have to pay in return for concessions by European partners, it will be more difficult now."

"PRINCE CHARMING"

The loss of the telegenic "prince charming" from Merkel's cabinet came at the start of a month of intense wrangling on reforming the European Financial Stability Facility (EFSF) and just before a vital March 27 regional election in Germany.

The vote in Baden-Wuerttemberg, which Merkel's Christian Democrats (CDU) has ruled since 1953, is the most important of seven state elections this year and losing would be a body blow to the chancellor.

She moved swiftly to limit the damage of Guttenberg quitting by appointing one of her most trusted aides, Thomas de Maiziere, to succeed him and bringing Bavarian CSU parliamentary floor leader Hans-Peter Friedrich in as interior minister.

"Just think of it this way," wrote the economic website Eurointelligence.com. "Merkel has lost by far the most popular member of her cabinet, and is about to agree the least popular policy measure in recent times -- the extension of the EFSF."

The decisive EU summit comes two days before the state poll in Baden-Wuerttemberg, where a center-right coalition of CDU and the liberal FDP is fighting to avoid its first defeat in more than half a century.

Even before Guttenberg's exit, the chancellor was under strong domestic pressure not to provide more help for euro zone weaklings, either by increasing German guarantees for the rescue fund or by allowing it to buy bonds in the market or fund debt buy-backs by distressed states such as Greece or Ireland.

"The internal pressure on the government and Merkel has risen strongly in the past 10 days. The motion passed by the parliamentary groups of the CDU/CSU and FDP is just as much pressure as the timing of the regional elections," said Peter Becker, an analyst at the German Institute for International Politics and Security.

"And then there's the sword of Damocles with the constitutional court."

The court is to rule this year on lawsuits by Eurosceptics who charge that German participation in last year's bailout for Greece and in the EFSF breached the so-called "no bailout clause" in the EU treaty.

GERMAN SUCCESS

Merkel has been preparing the ground for a "grand bargain" on March 24-25 by urging euro zone countries to sign up to German-inspired measures such as national laws to curb public debt and deficits, a common corporate tax base and provisions linking the retirement age to demographic trends.

In return, France and other euro area states expect Berlin to accept an increase in the effective lending capacity of the EFSF, and more flexibility for it to help states under pressure.

"Merkel will try to get a package like the 'competitiveness pact' which she can sell at home, showing that the lessons learned in Germany's domestic experience are being shared at the European level," said Josef Janning, director of studies at the European Policy Center think-tank in Brussels.

However, the package has already been watered down because of euro zone reluctance, and Merkel's weakened domestic position has increased doubts about whether she will be able to accept a stronger and more flexible euro zone rescue fund in exchange.

"The CDU is trying to make voters believe that the chancellor is trying to achieve that Germans will have to pay as little as possible," said Gerhard Schick, finance policy spokesman of the opposition Greens party.

"However, as she is weakened, she cannot make any decisions with a long-term perspective but needs to focus on short-term election wins."

Ulrike Guerot, an expert on Germany at the European Council on Foreign Relations, said that even before Guttenberg's departure, she was pessimistic that Merkel could agree to any significant strengthening of the rescue fund.

"It was already clear that the March summits would not produce a clear solution that would be a game changer. This is not going to make any difference," she said.

(Writing by Paul Taylor; Editing by Matthew Jones)