Euro Tipped to Trade with Positive Tone on Monday as SPD Vote to Prop up Merkel

© Christian Müller, Adobe Stock

Reports suggest the SPD membership have voted in favour of their party supporting Angela Merkel in a coalition government.

The vote will allow the formal establishment of a government in Germany after the months of uncertainty which resulted ofrom no single party managing to gain a majority in the country's Bundestag in the 2017 elections.

The SPD party - which was largely decimated in the 2017 vote - can however provide Merkel with the requisite majority to govern. However, many in the party felt their base was eroded having supporte Merkel in the previous 'grand coalition' agreement; doing so again was seen as risking further decline in popularity.

From a currency perspective, the outcome is positive for the Euro as had the SPD voted to not support Merkel, a question mark would have been placed over Merkel and the European integration project.

"German politics would become a mess: no coalition of centre parties, perhaps a minority government and possibly no Merkel – who has been a stabilising force for years. A no even raises the possibly of snap elections, which could help the right-wing, anti-immigration AfD party," says Peter Rosenstreich, an analyst with Swissquote Bank in Gland, Switzerland.

"The binary aspect of this vote makes it worrisome. Either we’ll get a big sigh of relief, or a big headache," adds the analyst.

The implications for the Euro exchange rate were therefore sizeable, and the market-friendly outcome to the vote could allow some of this uncertainty to be unwound which could see the seingle-currency rise.

Hans Redeker, Morgan Stanley's chief foreign exchange analyst based in London told his clients ahead of the weekend that if "the SPD rejects the coalition proposal, we expect EURUSD to fall to 1.16/1.17."

Considering that EUR/USD was 1.23 at the time, it was plain to see this forecast suggests a sizeable slump in the Euro!

And this matters for the Pound which has ironically often been seen as something of a safe-haven buy when investors are nervous across the channel, #despitebrexit.

Recall, the Pound-to-Euro exchange rate peaked at 1.20 ahead of the French election before fading right back on the pro-Euro victory of Macron?

Above: GBP/EUR in 2017 saw a run up to the French elections and a strong Euro recovery following Macron's victory

"GBP behaved as an unlikely albeit intuitive safe-haven as investors took the view that whatever threatened the unity and integrity of the Euro area justified less of an idiosyncratic Brexit risk premium in GBP," says  Paul Meggyesi, vice president of global currency and commodity strategy at J.P. Morgan.

Morgan Stanley meanwhile remain "long-term buyers of EUR" on any dips in the single currency.

The other political event to watch are the elections in Italy, but by all accounts the potential outcomes are deemed to be of little threat to Eurozone integrity and there is therefore little Euro negativity seen.

Morgan Stanley economists say their base case is for no party/coalition to win enough seats to govern alone.

"The election will likely be followed by a protracted period of negotiations which could have short-term impacts on the EUR, but we believe the Italian election is unlikely to have a lasting impact on global growth and risk sentiment, and hence limited long-term implications for the common currency," says Morgan Stanley's Redeker.

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