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What a weakened Merkel will mean for the euro currency in the coming months

  • The common currency has been under pressure since markets opened Monday after provisional results showed a weakened Angela Merkel
  • Traders seem divided when it comes to the euro's performance in the near term
  • Sunday's vote surprised many traders with a more fragmented German parliament

The future seems a little more uncertain for the euro following the outcome of the German election.

The common currency has been under pressure since markets opened Monday after provisional results showed a weakened Angela Merkel and a surging far-right Alternative for Germany (AfD) party that gained its first seats in parliament. The currency fell 0.6 against the dollar for the session, trading at $1.1872 at around 1:00 p.m. London time.

Traders seem divided when it comes to the euro's performance in the near term, but point out that the European Central Bank (ECB) will still be the ultimate underlying factor for the currency.

"The reaction in the EUR and in the credit markets is predictable, but with the ECB still a powerful force in the European debt markets, the moves are unlikely to turn violent," Stephen Gallo, European head of FX strategy at BMO Financial Group, said in a note.

Sunday's vote surprised many traders with a more fragmented German parliament. Merkel's center-right Christian Democratic Union (CDU) and its Bavarian sister-party the Christian Social Union (CSU) won 33 percent of the vote, down from 41.5 percent in the previous election. The pro-business FDP party, which placed fourth with 10.7 percent of the votes, has said it is open for coalition talks with Merkel's CDU. The Greens are set to join coalition talks too, which could ultimately form Germany's first four-party government in decades. However, coalition talks will not be easy. At the same time, the far-right AfD beat pollsters' predications and got 12.6 percent of the vote share.

"This is a turning point in German politics, but nothing dramatic changes in the short-run as the coalition building process starts. The ECB is still on course to taper quantitative easing in the coming months and the USD is still in a multi-month downtrend," Gallo from BMO added.

Most strategists believe that indeed the vote isn't going to change much of the political direction, but are divided when it comes to the performance of the currency against the dollar.

"We see the euro to trade sideways for a while as the USD rebounds from having fallen a bit more than was justified by the fall in real yields," Lothar Mentel, CEO of Tatton Investment Management, told CNBC Monday.

He added that Merkel's re-election, despite the weaker voting figures compared to the previous election, shouldn't change politics much. "The main change should be an atmospheric one," he said.

Kit Juckes, global fixed income strategist at Societe Generale, told CNBC Monday: "It's not a big (euro-dollar) move."

He said that the euro-dollar trade should hold around $1.19, but if coalition talks in Germany drag on, the currency will move further down. "If it takes a very long time, that would be a good reason for the euro to drift lower over the course of this week," he said.

Jane Foley, head of forex at Rabobank, told CNBC that: "On balance, we are of the view that EUR/USD could be choppy around current levels on a one to three month view. While we are forecasting a move to EUR/USD1.22 on a 6-month view, European politics constitutes a risk to this outlook."