Germany's Election Result Was Bad For France and Britain

Germany's election over the weekend achieved the difficult feat of both maintaining the status quo and delivering an upheaval that threatens months of negotiations to form a government, roadblocks to further EU integration and no respite in Europe's hardline approach to Brexit.

"Negotiations (to form a coalition government) could take 3-6 months," noted UBS economist Ricardo Garcia on Monday. "Our best estimate is that the new government will be in place in the first quarter of 2018."

Little wonder that the euro wobbled on Monday, September 25, falling over half-a percentage point against the dollar as traders pondered the prospect of near paralysis in the German parliament.

Where the euro heads from here will depend on the lauded negotiating skills of Angela Merkel - who will remain as Chancellor after her party won a third of the vote.

The fate of EU reform, and more particularly those reforms being pushed by France's new President Emmanuel Macron, are likely to sit at the heart of the horse-trading to form a governing coalition. That in turn means that German backing for Macron's proposals of common EU budgets, potential debt mutualization and a new euro-wide minister of Finance are now less sure.

What does seem likely is that the SPD, Merkel's junior partner in the current government and perhaps the strongest supporter of the French plans, will not be a part of the next government. The SPD, led by former President of the European Parliament Martin Schulz, said it will not enter a new coalition after it garnered just 20% of Sunday's vote - its worst result since 1950.

Unless the SPD performs an about face, Merkel will have to find common ground with the pro-business FDP and the Greens, which took 10% and 7.7% of the vote respectively.

That is a problem for those who are pro-European integration mainly because of the FPD.

"FDP leader Christian Lindner has ruled out joining a coalition with Chancellor Merkel if she were to support French proposals to deepen fiscal integration in the Euro area," noted Goldman Sachs.

Indeed, much of the FDP's policy appears to be irreconcilable with Macron's ambitions. The FDP pledged in its election manifesto to phase out the European Stability Mechanism, which provides loans to struggling members, and open the way for countries to leave the European Monetary Union (EMU) without leaving the EU. Macron, in contrast, wants to reinforce financial support for struggling EU members and create common budgets to support growth-oriented investment.

The Greens are likely to prove more amenable to Macron's vision, but are on their own collision course with the FDP. The Greens want increased subsidies for low-carbon energy projects, while the FDP wants to erase them.

One thing that all the parties seem to agree on is that the EU can't afford to abandon its hard-line negotiations with regard to Brexit. The SPD, FDP and Greens all campaigned on a promise that Britain would not be allowed to "cherry pick" EU benefits as part of its exit deal.

Unfortunately for Britain, that was the one thing they also all had in common with Merkel's party.