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Merkel wins again, but EU politics just got more complicated

Equity markets on both sides of the Atlantic managed to complete a decent week of gains despite continued tension between North Korea and the US, while the US Federal Reserve signalled that it remained on course to raise rates once more before the end of the year, as attention turned to this weekend’s German election, which more or less went according to script.

While it was no surprise that Angela Merkel was able to win a fourth term as German chancellor, the parliamentary arithmetic became slightly more complicated with a much better than expected performance from the populist AfD, which managed to get well above the 5% threshold which will give them a significant presence in the German Bundestag over the next four years.

Their performance in becoming the third largest party in German politics, along with a disappointing performance from Martin Schulz’s social democratic party SPD, which recorded a post-war low in terms of vote share, means that the forming of a coalition government is likely to be much more problematic than it was in 2013. With hindsight it would appear that his decision to leave his position as president of the European parliament was not one of his better ones.

This weekend’s outcome is also likely to make the prospect of any sort of political reform of the EU much more problematic given the decline in the share of the vote of the combined two major parties. While they still have a combined share of over 50% it is by no means certain that the SPD will want to continue the previous arrangement given the damage already done to their political base.

The smaller parties are now likely to have much more influence with the FDP in particular, previous coalition partners of Angela Merkel prior to the 2013 election, may well have much more influence this time round which suggests that French President Emmanuel Macron’s plans to pool sovereignty on certain issues, including a eurozone budget and finance minister are likely to end up dead in the water.

The pound underwent a late dip at the end of last week after ratings agency Moody’s downgraded the UK’s credit rating from Aa1 to Aa2, citing the potential relaxing of fiscal austerity and economic uncertainty as a result of Brexit, and the prospect that a new trade arrangement will take years to negotiate. While the reasoning behind the downgrade comes across as fairly straightforward, the timing was rather curious given Friday’s speech by Prime Minister May that a two-year transition period was being sought in order to address the very uncertainties Moody’s was warning about.

Ultimately, while the timing of the downgrade was politically difficult for the UK government, markets care much less about what ratings agencies think than they did ten years ago, and UK gilt yields are unlikely to suffer any long-term change as a result of Friday’s announcement.

On the data front we’ll be getting the latest German IFO business survey for September, which in the wake of last week’s bumper flash PMI numbers is expected to show another improvement, reflecting a German economy that looks in rude health.

This outperformance is likely to increase the pressure on ECB president Mario Draghi to paring back the ECB’s currently loose monetary policy stance. His speech later today in the European parliament is likely to be picked over for clues about the current thinking behind that process.

EUR/USD – continues to trade in a box range between the mid 1.2000’s and the recent lows at 1.1820, with the potential for a possible triple top, and a 250 point break out. A break below the 1.1800 area is likely to prompt further weakness towards the 1.1600 area, while a move through 1.2100 targets 1.2350.

GBP/USD – the 1.3450 continues to support the pound, with further support at the 100 week MA at 1.3385. A move through the highs last week at 1.3660, opens up a move towards 1.3755, on the way to a move towards the 1.4000 area.

EUR/GBP – the 200 day MA around the 0.8700 area remains the next target while below this week’s high at 0.8900. A break of the support area around the 0.8770/80 area, could well be the catalyst for just such a move. 

USD/JPY – has continued to move back towards the top of its recent range moving up towards 112.90 which is trend line resistance from the highs this year. We now have support back at the 111.70/80 area.

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