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Analysis
Queen Angela the Uneasy

Queen Angela the Uneasy

Merkel dilemma: ECB bond purchases may not restart

by David Marsh in Madrid

Fri 22 Sep 2017

Fourth terms are not kind to German chancellors. Angela Merkel, preparing to enter her fourth successive period in office after her expected victory in Sunday's parliamentary election, looks likely to be dubbed the 'Queen of Europe', by far the continent's most experienced and influential politician. Yet her crown will sit uneasily – a result, above all, of the probable parliamentary entry of the anti-euro, anti-immigrant party Alternative for Germany (AfD).

Merkel's reduced manoeuvring room in coalition-building and waning hold on power have big implications for the European Central Bank's quantitative easing bond purchases. These policies have, paradoxically, spurred a European economic recovery, yet undermined Merkel's core support.

Merkel's two long-lived Christian Democratic Union predecessors, Konrad Adenauer and Helmut Kohl, after final electoral victories in 1961 and 1994, both ran into progressive problems in their fourth terms, leaving office much diminished in 1963 and 1998.

Merkel's destiny may be similar. In almost any political constellation after Sunday's vote, the chancellor will be weakened. If the far-right AfD strengthens beyond the party's expected 10% of votes, she may remain in a coalition with the Social Democratic Party (SPD). That would be a sizeable disappointment compared with her target of teaming up with the CDU's traditional allies, the liberal Free Democratic Party, expected to re-enter parliament after a four-year absence. Some polls see the AfD scoring 12%, gaining 85 parliamentary seats.

The SPD, after a lacklustre four years of power-sharing, is likely to be more hostile to Merkel than hitherto. Furthermore, if the 'grand coalition' is renewed, the AfD – formed only four years ago – would become the largest opposition group. That would give it great influence in parliamentary proceedings and in the media, an astonishing surge for the first far-right party in the German parliament since the 1950s.

If, on the other hand, Merkel proceeds with an alliance with the FDP – still the most probable outcome – she is likely to do so only in an uncomfortable three-way grouping with the Green ecology party, close to the CDU in some economic and industrial fields but far softer on euro issues.

The AfD's parliamentary debut, and the return of the FDP, will sharpen the tone of parliamentary debate on Europe. Both take a harder line than Merkel on issues like financial support for debtor countries and the ECB's QE policies. In famous remarks in April 2016 Wolfgang Schäuble, the finance minister, attributed half the blame for the AfD's rise on ECB President Mario Draghi's easing policies, which have reduced interest rates for German savers and fuelled anxieties over eventual inflation.

The German election comes a month before the next ECB policy meeting on 26 October when the central bank will discuss a reduction in QE purchases next year, both because it is running out of eligible bonds to buy and because earlier deflation fears have virtually disappeared. The ECB council will probably not formally decide an end-date for bond purchases, partly reflecting fears that – in view of German antagonism – it will not be able to restart the programme once it stops.

The AfD has been boosted by a mid-August statement from the German constitutional court explaining 'important reasons' for why the ECB's QE may be illegal. It may contravene a ban on monetary financing, overstep the ECB's mandatory limits, and expose German taxpayers to unquantified financial risks.

The European Court of Justice has to answer key questions before the German court gives a verdict next year, which could render QE inoperable in about 12 months. These circumstances pose a near-insuperable dilemma for Draghi and Merkel. Setting a date for ending QE would expose Italy in particular to grave financial risks ahead of its 2018 parliamentary elections. Yet continuing the programme will bolster the AfD and expose further Merkel's vulnerability.

Coinciding with all these challenges, France will be seeking fresh euro concessions from Merkel, at a time the German parliament will become far less open to delivering them. Merkel will be the victor on Sunday night – but her triumph is likely to be short-lived.

David Marsh is Managing Director of OMFIF.

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