Germany’s Eurozone Approach Unlikely to Change Post-election, says Fitch

The German authorities’ approach to the eurozone crisis is unlikely to alter significantly, whatever coalition chancellor Angela Merkel’s Christian Democratic Union (CD and Christian Social Union (CSU) form, despite the collapse of the Free Democratic Party, Fitch Ratings says.

The credit ratings agency (CRA) adds that the pending election in Germany, which took place at the weekend, had slowed the bloc’s crisis response in 2013. However, a number of potential flashpoints between now and year-end will highlight the unresolved issues and tensions within the eurozone on how best to deepen economic and monetary union (EMU).

The political consensus in Germany reflects popular support for the country’s existing approach to the eurozone, with its emphasis on fiscal and economic reform to improve competitiveness, and resistance to debt mutualisation. Politicians are also mindful of the possibility of legal challenges in the Constitutional Court to extending the remit of existing stabilisation mechanisms.

This is reflected in pre-election comments from CDU/CSU, Social Democratic Party (SPD), and some smaller parties, who oppose using European Stability Mechanism (ESM) funds for direct bank recapitalisation without strict conditionality; they oppose a common deposit guarantee fund; and are in favour of eurozone members that receive support having to make a more formal commitment to reform.

On debt mutualisation, the SPD has significantly toned down its earlier support for common eurozone bonds. Overall, Fitch does not expect the German authorities to significantly modify their approach to the crisis post-election even where it is at odds with other eurozone members or central institutions.

Market pressure on policy makers to speed up their response to the crisis may lie dormant as long as the European Central Bank (ECB) stands ready to intervene in sovereign bond markets. However, a number of unresolved issues will re-emerge in the coming months.

There is little clarity about the terms of future EU support for sovereigns. This remains a key issue and has already resurfaced in talk of a possible funding gap in 2014 in Greece’s second programme, which will require additional financing to be identified this autumn (Fitch has previously acknowledged the possibility of minor funding shortfalls appearing after 2013).

Ireland’s programme is due to end in December and Portugal’s in May 2014. Fitch’s base case remains that Portugal will need and receive further official support; deciding how to provide it may test relations between Portugal and its international creditors, including Germany, as Portugal seeks to have its deficit target under the programme increased.

Policy makers will also try to decide the final shape of the Single Resolution Mechanism (SRM) for eurozone banks this autumn. Germany’s preference (shared by some other eurozone members) is that current proposals could require changes to the Lisbon Treaty and approval by all EU members; this threatens to complicate or delay a decision based on existing proposals, further slowing progress towards banking union in the eurozone.

The expected continuity in Germany’s approach to the crisis suggests that the process of deepening EMU integration via institutional reform and achieving greater clarity on the terms of financial and fiscal risk sharing will remain slow.

This is in line with Fitch’s long-standing base-case that resolving the crisis will take time and the eurozone authorities will continue with an ad hoc policy-making approach. Political commitment to maintaining the currency union remains strong and the CRA’s base case is that a break up will be avoided, but the path to resolution will remain bumpy.

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