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Investors focus on ECB ahead of German election

The attention of investors will be squarely on Germany this week — but not on Angela Merkel’s probable march to a fourth term as chancellor.

Instead the focus will understandably be on Thursday’s meeting of the European Central Bank’s governing council, which is expected to debate when to unwind a €2tn bond-buying programme.

Not only does Ms Merkel hold a commanding lead over Martin Schulz, her challenger from the Social Democrats but, in contrast to the battle for the French presidency, there is no chance of the winner wanting to scrap the euro and tear down the edifice of European Monetary Union.

Michael Krautzberger, a fund manager at BlackRock, describes investors as being “quite relaxed” about the September 24 federal elections. “With Brexit and the French election we had huge positions and risk management in place, but in the German election the options are shades of grey.”

Since Mr Macron defeated Marine Le Pen in May, it has been an improving economy and expectations for ECB policy, rather than politics, that have animated European markets. The euro last week breached the $1.20 mark for the first time since early 2015, taking its gain for the year against the dollar to 13 per cent.

However, a stronger euro has weighed on share prices with the Euro Stoxx 600 having slipped more than 5 per cent from its peak in May when the single currency was trading below $1.10.

For all the current focus on the currency and bond tapering, investors may come to regard Germany’s election as a significant moment for the eurozone, should a victorious Ms Merkel team up with Mr Macron to form an axis that drives greater fiscal integration — something that some believe is necessary to strengthen monetary union.

Late last month, Ms Merkel said she would give her backing to a “small” common budget for the eurozone along with a finance minister for the region.

The German chancellor’s re-election “would bring continuity not only to Germany but also the wider eurozone” which is “crucial to the [euro] currency”, says Sven Balzer, senior strategy manager at Coutts. “Closer collaboration between France and Germany” is widely expected as the eurozone’s future is one of Ms Merkel’s “key priorities”.

If asked about the election at his press conference on Thursday, ECB president Mario Draghi is unlikely to be drawn. However, it would be no surprise to hear him again call on eurozone governments to help sustain and strengthen the region’s recovery, particularly as the central bank contemplates scaling back its stimulus programme.

With the economy recording its fastest expansion in three years in the second quarter and the country having a large trade balance, it is Germany that has been under the greatest pressure to adopt a more stimulative fiscal policy.

Strategists expect the election to deliver some, albeit limited, movement on this front. The most likely electoral outcome is “a somewhat looser fiscal stance,” according to analysts at RBC Capital Markets.

However that fiscal easing will not top 1 per cent of German GDP, so “the sums targeted are probably too small to really impact the markets”, says Peter Schaffrik, chief European macro strategist at the bank.

That will have implications for German government bonds, he adds, as it will “keep net new issuance at bay”.

“Coupled with the ECB’s ongoing [bond] purchases”, that means the current scarcity of Bunds is likely to continue.

The yield on two-year German debt hit a low for the year of -0.949 per cent in late February as markets were spooked by polling suggesting the National Front leader Mrs Le Pen was gaining in the French polls. While the yield remains well above those lows at -0.75 per cent, it has been trending downwards again since late June.

It is central bank policy and the state of the economy that will continue to drive markets. “We are seeing a normal cyclical upswing, and politics is becoming less important again for European markets,” says Myles Bradshaw, head of global aggregate fixed income at Amundi, Europe’s largest asset manager.

Should Ms Merkel be returned as chancellor and overcome domestic political opposition to push for fiscal integration, politics could yet drive markets again. But investors are not betting on anything soon.