Euro Falls as Merkel Faces German Coalition Test After Win

(Bloomberg) -- The euro dropped as Angela Merkel's victory as German Chancellor was marred by a worse-than-expected result that leaves her facing tough coalition talks.

The common currency snapped a two-day rally as her current coalition partner, the Social Democratic Party, ruled itself out of a deal with Merkel's Christian Democratic Union, making the formation of a government more challenging. Instead, she will have to negotiate with the pro-business Free Democrat Party and the Green Party, something that could take months.

While many currency analysts see the euro ending the year above $1.20 after its 13-percent surge so far, protracted talks to form a government could weigh on market sentiment. The FDP is against further European Union integration, while the entry of the anti-immigrant Alternative for Germany party into parliament could pressure Merkel from the right.

The euro slipped 0.4 percent to $1.1903 in early Monday trading in New Zealand.

“Currencies are less liquid this early in the Asia session and the price action may be only the beginning of a more meaningful correction lower in euro crosses later today,” said Credit Agricole SA strategist Valentin Marinov.

The outcome of the election may trigger a flight to safety, which could benefit the Swiss franc and mean a bid for German government bonds. The franc has weakened about 8 percent against the common currency this year, while 10-year bund yields have more than doubled.

Here are some comments from analysts on the election outcome:

Credit Agricole

  • The Anti-Europe Alternative for Germany Party's better-than-expected showing could cause some jitters for euro crosses, “given that investors were hoping for a more decisive defeat of the anti-EUR party before the Italian election in early 2018,” said strategist Valentin Marinov
    • “That said, any dip in EUR could remain a buying opportunity ahead of next week's inflation data and the October ECB meeting”

    SEB AB

    • Merkel's mandate going into negotiations about deeper euro integration does not look quite as strong, making the result marginally less market-friendly than expected, said cross-asset strategist Thomas Thygesen
    • “I'd say this is in line with our expectation that the euro would pause around $1.20 versus the dollar and then maybe retrace a couple of percent over the autumn”
    • “The AFD above 10 percent suggests that even here the stakes are high: if the European project doesn't fly this time in a way that voters like, Germany could look less politically stable in a few years”

    UBS Wealth Management

    • The Swiss franc could be one of the main winners from the German election after the SDP ruled themselves out of a coalition, said chief investment officer for Germany Maximilian Kunkel
    • “The Swiss franc has over-extended its move to the downside against the euro, so there will be strength again because people will realize that there are still some structural issues in Europe that have not been addressed by the main leaders”

    To contact the reporter on this story: John Ainger in London at jainger@bloomberg.net.

    To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Neil Chatterjee

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