Euro strengthens ahead of German Elections

By Luke Walden, Godi Financial

This weekend (24th September 2017), the German public take to the polling booths to vote for the party they believe best suited to lead them forwards. It’s been 4 years since the last Federal Election which saw Angela Merkel and her CDU party stay in power for a third consecutive time – can she prevail again?

 

Merkel is odds-on favourite to win her fourth term with most high-street bookmakers. It must be said these odds have shortened considerably since last year when her approval ratings took a nose dive after the awful terrorist attacks and subsequent concerns around her refugee and immigration policies. As was feared in the UK, along with other European nations, that the German far-right party, Alternative for Germany (AfD), was seen to make substantial gains but that euphoria has dampened quite dramatically. Maybe Macron’s win in France earlier in the year set the trend there.

 

Crucially, Merkel’s successes in the regional elections in May 2017, in particular winning the vote in Schleswig-Holstein which had previously been a Social Democrat stronghold, indicates that the German public have moved on from their previous stance and are willing to give the CDU another crack. Of course, in amongst all of this we have the UK’s Brexit negotiations taking place and I would imagine the thought of a new party taking charge at such a crucial point in political history doesn’t fill the nation with joy.

 

A leadership election in Germany is of keen interest to the UK. Political and economic relations between the two nations is strong with Germany ranked as the UK’s largest source of imports and second largest destination of exported products. Clearly if there were to be a leadership change this month, that would throw further complexity in to the UK’s cauldron of negotiations not only with Europe over Brexit, but also with Germany over trade deals. This would not be an ideal scenario for Theresa May and her cabinet.

 

The core trading relationship between the two powerhouses is largely focussed around the automotive industry. It’s suggested that German manufactured automobiles sold to UK consumers is valued around £25 billion annually and the trade surplus as a result for Germany makes up a large proportion of its annual GDP. So although the UK will be hoping for some continuity and stability with the upcoming election, let’s not forget that whichever party is victorious will be very aware of the importance of working closely with the UK on this front.

 

The thought of Merkel regaining power has pushed the Euro higher versus many of its peers in recent months. Against the US Dollar it has seen a considerable rise, around 15% since the start of 2017 – that’s nothing to be sniffed at. Of course, this isn’t totally attributed to Merkel and the upcoming elections, but it does show that confidence is booming in Germany right now and the country is enjoying a period of relative cheer.

 

But as we have seen closer to home, things on the political spectrum can change dramatically in a very short space of time. I do envisage Merkel to get elected once more, so as a risk-reward play I would suggest it might be wise for UK and US businesses that are exposed to the Euro – export companies for example where a strong Euro is good for business – to secure rates against their home currency to negate any risk of the Euro moving against them.

 

It must be said, however, that September has already seen a significant rise in the value of Sterling against both the Euro and the US Dollar. This is in part due to encouraging economic data – especially in the manufacturing sector which saw production jump by 0.5%m/m – but also a strong indication from the Bank of England that they may be ready to move on raising UK interest rates for the first time in a decade. It is expected that any increases would be marginal to avoid any adverse reactions, but the BoE do seem to have wiggle room now as rising inflation and general stronger household spending seems to be on the rise.

 

Businesses with exposure to overseas currencies should always be looking to firstly reduce their foreign exchange (FX) risk to potential adverse market movements, but also take advantage wherever possible of beneficial price action which could solidify their business model. As mentioned above, for UK exporters that haven’t yet implemented a robust FX strategy, this could be an ideal time to capture the recent Euro strength.

 

If Merkel and her CDU party retain control, the Euro will likely move higher ever so slightly – a Merkel victory is largely priced in to the current Euro rate I believe. But if we were to see a UK-style run in to the Election Day, the Euro will surely destabilise. Remember, markets generally dislike uncertainty and if exporting businesses proactively lock in their currency at these levels, it could potentially protect them against any large unforeseen movements.