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A weakened Merkel means EU integration will now be put on the back burner

German Chancellor and Head of the Christian Democratic Union party (CDU) Angela Merkel on election night at the CDU headquarters in Berlin, Germany on September 24, 2017.
German Chancellor and Head of the Christian Democratic Union party (CDU) Angela Merkel on election night at the CDU headquarters in Berlin, Germany on September 24, 2017.

Europe's politically supercharged year has ended with a jolt of excitement as Germans went to the polls on Sunday.

It had been dubbed a "sleep campaign" and all different shades of "boring" by the German media, and it was widely expected that markets would react with a big fat "gähn" (German for yawn).

However, what we got was a stark reminder that the populist threat is a real one, as the far-right Alternative for Germany (AfD) party entered parliament with 12.6 percent of the vote, making it the first far-right party to enter the German Bundestag since 1960.

This strong showing sent shockwaves through Germany's political and business elite and was widely seen as a backlash against Chancellor Angela Merkel's "open door" refugee policy.
While Merkel will continue to govern for a fourth term, her party's support fell to its lowest level since 1949, making the task of forming a coalition a much tougher one this time around. The euro fell slightly against the dollar overnight Sunday before recovering some losses.

In another shock, the Social Democrats have announced they will go into opposition, leaving only one coalition possible – the so-called Jamaica coalition (CDU/CSU, the liberal FDP and the Greens), so named because of the different party colors.

Let's start with the good news. Domestically, all of the parties above are still committed to sound public finances of a balanced budget and "no new debt." Equally, economists at UBS Wealth Management add that "moderate income tax cuts worth ½ -1 percent of GDP (gross domestic product) seem likely, as all parties have included those in their manifestos."

But the tougher nut to crack will be the stance on Europe.

According to Barclays analysts on Monday morning: "A Jamaica coalition would likely make it more difficult to pursue further euro area reform. Making tough decisions with only a fragile 52.4 percent majority is hard. The AfD result could move some CSU politicians towards a more hawkish stance on fiscal risk sharing. The Greens and FDP also have opposing views on EU policy."

UBS Wealth Management explains that "working towards transforming the ESM (European stability mechanism) into a European Monetary Fund is a part of all the major parties' manifestos, except for the FDP which rather wants to phase out ESM lending capacity and is most opposed to further European burden-sharing."

Interestingly enough, the liberal FDP had also been hoping to lay claim to the powerful Finance Ministry ahead of the election.

What it means for Europe should that scenario materialize is fewer bailouts.

A bland and predictable election has now turned into a possible turning point for Europe's integration. French President Emmanuel Macron's vision of a deeply integrated Europe which he will present on Tuesday might fall on deaf ears – as long as those pesky coalition talks persist. Even in highly efficient Germany, this will take months.

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