For Merkel, it could take three to tango

BERLIN (Reuters) - At first glance, Germany’s federal election looks like a done deal -- all major polls predict Chancellor Angela Merkel’s conservatives to come in first, a result that should mean no political upheaval in Europe’s biggest economy.

But that’s the first glance. The devil will be in the detail of what coalition is likely to come after Sunday’s vote, and with it whether Merkel’s economic policies can remain in situ.

Those policies have reigned over booming growth and rising consumer confidence.

The status quo, though, will depend to a certain extent on how Merkel’s centre-right CDU/CSU bloc fares compared with her incumbent junior coalition partner, the Social Democrats (SPD).

The far-right Alternative for Germany (AfD) party, the pro-business Free Democrats (FDP) and others could potentially hold the balance.

So a few percentage points will decide Merkel’s coalition options and her policy agenda for the next four years -- with consequences for Berlin’s stance on euro zone integration, tax cuts, state spending and the privatization of state assets.

“It’s all about politics next week -- and that means German politics,” said Andrew Bosomworth, a senior portfolio manager at Pimco, one of the world’s largest bond funds.

The base scenario is that Merkel will win the election and remain chancellor for a fourth term. “The big question is with which of the other parties she will team up,” Bosomworth said.

Coalition building will be complicated by the fact that the anti-immigration AfD and the socially liberal FDP are forecast this year to easily pass the five percent threshold to enter the Bundestag lower house of parliament after failing in 2013.

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This means that traditional two-party alliances -- such as a “black-yellow” coalition between Merkel’s conservatives and the FDP or a “red-green” coalition between the centre-left SPD and the Greens -- are likely to fall short of a stable majority.

The most likely scenarios are therefore another “grand coalition” between Merkel’s bloc and the SPD -- usually a last resort combination -- or a three-way alliance untested at national level between the conservatives, the FDP and the Greens -- dubbed the “Jamaica coalition” due to the parties’ colors.

Both options would broadly mean a continuation of CDU/CSU’s economic policies, including closer cooperation within the euro zone, sealing more free trade deals and granting minor tax cuts.

“If Merkel’s conservatives win as expected, the market reaction is likely to be calm. A Merkel victory is basically priced in,” Bosomworth said.


However, last year’s elections in the United States and Britain showed that pollsters can get it badly wrong. There is also a chance that the conservatives and the FDP could get just enough votes to form a black-yellow coalition.

Such a scenario could bring some market volatility since the FDP is less open to helping other euro zone countries and its leader has criticized French President Emmanuel Macron’s plan to create a joint budget for the single currency bloc.

Some investors have even warned that a black-yellow coalition could lead to a renewal of the euro zone debt crisis.

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Such fears are based on the idea investors could shift their money out of government bonds from southern European countries.

Berenberg economist Holger Schmieding, however, reckons this is all exaggerated. “An FDP presence in government would not jeopardize European reforms,” he said.

With the FDP calling for privatization of state assets such as the government's stakes in Commerzbank CBKG.DE, Deutsche Telekom DTEGn.DE or Deutsche Post DPWGn.DE, a black-yellow coalition scenario is likely to push up some stocks.

"The DAX .GDAXI could make a small jump if there should be a majority for black-yellow," said Joerdis Hengelbrock, portfolio manager at Sal. Oppenheim.

Regardless of the uncertainty surrounding Merkel's future coalition partner or partners, investors such as Berkshire Hathaway's BRKa.N Warren Buffett are banking on the pastor's daughter to remain at the helm of Europe's biggest economy.

“Merkel is an extraordinary personality,” Buffett told business daily Handelsblatt. “Germany and the world, from my point of view, need a leadership personality like Angela.”

Reporting by Michael Nienaber Editing by Jeremy Gaunt