German Chancellor Angela Merkel won a fourth term in office on Sunday 24 September but will have to build a coalition to form a government. This follows a surge by the populist and anti-immigration Alternative for Germany (AfD) which won 13.5% of votes. This is the first time the AfD has had any seats in the Bundestag and is an indication of lingering political uncertainties on the continent. It remains to be seen how much policy influence the AfD will achieve.
Stock market reaction has been muted and the DAX index has been flat over the last month. The Euro has weakened 5% against Sterling in the last month and faced heavy selling against the Pound in the immediate aftermath of the election. This will compress gains in European equities and bonds for unhedged Sterling based investors; but with currencies moving quite unpredictably this may prove short term, especially as Brexit plays out. To give some context, the Euro has strengthened 2.6% against Sterling in the year to 27 September.
On the positive side economic recovery has gained traction across Europe this year and corporate earnings have begun to recover. Unemployment across the Eurozone is at eight-year lows, while manufacturing leading indicators are at six-year highs. Inflation and interest rates remain low with the ECB continuing to purchase government and corporate debt.
The upcoming Italian election has the potential to create short term “noise” in European equity markets. The main threat to the more traditional ruling parties has been the Five Star Movement, which wants to hold a referendum on the Euro and NATO membership. It remains to be seen whether the Italian electorate will embrace such radical changes.