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Analysis
Berlin strains to flare again

Berlin strains to flare again

Merkel's battles – in Bavaria and beyond

by David Marsh in Berlin

Fri 31 Aug 2018

Strains in Chancellor Angela Merkel's three-party coalition, which appear to have died down during the summer, seem ready to flare again in coming weeks. This will significantly influence German policy-making in fields ranging from budgetary policy to precepts for reforming economic and monetary union.

One area for potential discord surrounds the nomination of a new president of the European Central Bank to succeed Mario Draghi in November 2019. Merkel appears to be moving towards confirming long-running conjecture that she will not push through at all costs the candidature of Jens Weidmann, the Bundesbank president.

A possible package deal could allow Germany leadership of the European Commission, with France taking the top ECB job. Peter Altmaier, a Merkel favourite, currently economics minister, could replace Jean-Claude Juncker as Commission president next year, becoming the first German to hold the post since Walter Hallstein in 1958-67. François Villeroy de Galhau, governor of the Banque de France, would be a prime candidate to take over from Draghi.

This solution could bring its own complications and conflicts. It could inflame German conservatives in the coalition and beyond who claim that Germany is succumbing to French-led dismantling of Bundesbank-style monetary orthodoxy. Critics of Germany would see it as a Berlin bid to curb the Commission's influence on EMU reforms and on rescue measures for weaker states.

A major factor contributing to Berlin coalition tension between Merkel's Christian Democratic Union, their Bavarian Christian Social Union allies and the Social Democratic Party (SPD) is the Bavarian state election on 14 October. This will be one of the most important provincial German polls since unification in 1990. The far-right anti-euro, anti-immigration party, Alternative for Germany (AfD) – now the formal opposition party in Berlin – is making a strong showing. Now under genuine pressure from the extreme right-wing for the first time since the 1950s, CSU looks likely to lose its habitual absolute majority in the southern German state.

New migration into Germany has declined sharply since the 2015-16 peak. The healthy economy, near-full employment and budget surpluses registered by Olaf Scholz, the SPD finance minister and vice-chancellor, underline German ability to absorb higher numbers of foreigners. However, in the Bavarian election the AfD is emphasising integration problems of already-arrived migrants, difficulties in expelling rejected asylum-seekers, and threatened new arrivals from troubled countries like Turkey or Libya.

Bilateral talks on migration flows with the eurosceptic Italian government will be complicated by Italian demands for Berlin to tolerate Rome budgetary overshooting and accept more euro area 'risk-sharing'. German officials believe speculators have shrunk back from large-scale attempts to destabilise the Italian bond market because the wider German-Italian 10-year bond yield spread has increased the cost of such transactions.

The euro bond market remains vulnerable to upsets. Long-running wrangles over the constitutional legality of the Bundesbank's participation in European Central Bank quantitative easing are likely to come to a head towards the end of the year. This will have no effect on the ECB's €2.5tn QE programme scheduled to end in December. Yet Berlin officials worry that constitutional court strictures could rule out Bundesbank participation in future bond-purchase action. This would increase the onus on European governments to find wider political solutions for reinforcing EMU, including channelling German taxpayer money towards debtor euro member states. Scholz has made great efforts to bridge traditional Franco-German divisions over euro area reform. However, smaller EMU states such as the Netherlands and Austria, now influenced by strong eurosceptic domestic opinion, are far less likely than in the past to accept European proposals worked out by Berlin and Paris.

Battling the SPD's poor opinion polls, Scholz does not hide his desire to succeed Merkel in the next federal election in 2021. He is on a collision course with the CDU after suggesting a highly expensive government pledge to guarantee pensions up to 2040. Discord over distributing Germany's budgetary largesse among European and domestic beneficiaries will be at the centre of Merkel's political battles – in Bavaria and beyond.

David Marsh is Chairman of OMFIF.

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