* Berlin seen maintaining conditional support for periphery
* Bond investors keep cautious exposure to Italy, Spain
* No significant German policy shift seen
By Emelia Sithole-Matarise
LONDON, Sept 23 (Reuters) - Euro zone bond investors are heartened that Angela Merkel looks likely to maintain Germany’s carrot-and-stick support for weaker economies but no-one is rushing to buy with no significant policy shift expected.
Germany, Europe’s biggest economy, has been the major contributor to bailouts for countries like Portugal, Greece and Ireland that have been shut out of capital market during the euro zone’s three-year debt crisis.
Many investors had seen the election campaign as an obstacle to crucial decisions on the bloc’s problems, such as new aid packages for Greece and potentially Portugal and were looking for progress one the make-up of the German government was clear.
Merkel’s conservatives notched up their best election result in two decades but fell short of an absolute majority and must now seek to forge a new coalition.
Her party may have to convince leftist rivals to join a coalition after their current allies, the Free Democrats (FDP) suffered a humiliating exit from parliament.
The Social Democrats, with whom she is seen most likely to share power, back the call from weaker economies to favour growth-oriented polices over austerity. The SPD’s support was crucial for Merkel to push through measures to defuse the euro zone debt crisis over the past year, including backing the European Central Bank’s bond purchase scheme.
Merkel’s strong showing, however, was seen giving her enough muscle to fend off more contentious demands such as issuing common euro zone bonds, earlier supported by the SPD, which would see Germany assuming more liability for weaker economies.
“This will likely mean a continuation of the policy which the Merkel government has been pursuing with regards to the euro area - a policy of support in return for reforms and austerity,” said Michiel de Bruin, head of euro government bonds at F&C Netherlands.
“We have been fairly constructive on the periphery. At the moment given this outcome we see no reason to change that.” The company, which has $140 billion of assets under management, holds Spanish and Italian bonds.
Italian and Spanish yields fell slightly on Monday. De Bruin said their 10-year yield premia over safe-haven German debt could fall to lows below 200 basis points seen in July 2011 from around 240 bps, especially if the tentative recovery in the euro zone economy gathered pace.
With the election out of the way, plans for a banking union with a single resolution mechanism for lenders in trouble, a key plank in European leaders’ efforts to resolve the debt crisis, could gain impetus.
“It’s (the election outcome) probably going to be a supporting feature for our exposure to peripherals,” said Rabbani Wahhab, senior fixed income portfolio manager at London and Capital.
“From a risk-adjusted perspective we would be adding to Italy and Spain but then we probably need to be a bit selective on Portugal and Greece but we certainly won’t be put off.”
London and Capital is “underweight” Spanish and Italian bonds but less so than it was about four months ago and has “very small” exposure to Portuguese and Greek debt, Wahhab said.
While many investors saw little change in German policies towards the euro zone resulting from a coalition between the conservatives and either the Social Democrats or the Greens, some said lengthy talks could unsettle markets. In the past, establishing a coalition has taken four to eight weeks.
“A grand coalition may also become unstable in the long run, as the SPD will likely try to avoid the same fate as in 2005-09 when it lost substantial voter support following its participation in a Merkel-led grand coalition government,” Citi strategists said in a note.