German Crisis Averted? SPD Ready To Negotiate With Merkel To End Political Deadlock

The Euro has jumped to a six week high following the latest record high print in the German IFO Business Climate index, which rose from 116.7 to 117.5 (exp. 116.6), but mostly as a result of what appears to be a breakthrough in the German political deadlock that some likened to "Merkel's Brexit moment", after Germany’s biggest opposition party, the Social Democrats, on Friday morning announced a reversal in their political strategy and said they are open to talks on backing a government led by Chancellor Angela Merkel, offering a way to break the Berlin deadlock and restore political stability to Europe’s biggest economy.

As the FT reports, the decision, announced after an eight-hour meeting of SPD leaders in party headquarters in Berlin wrapped up in the early hours of Friday, marks a U-turn for the centre-left party, which had vowed since September’s indecisive general election not to rejoin Ms Merkel’s centre-right bloc in a “grand coalition”.

Commenting on the latest political development, UBS economist Paul Donovan said that "the German SPD are discussing the possibility of some kind of support for the CDU, following talks with the German president. The German political crisis is not really looking very crisis-like. It is all very orderly and, frankly, a little dull."

Social Democrat Secretary General Hubertus Heil told reporters that the party is ready to start discussions if that’s the course that President Frank-Walter Steinmeier, who is trying to broker a deal, decides upon. Heil spoke after an eight-hour meeting of the SPD leadership in Berlin.  “The SPD is firmly convinced that talks are needed,” Heil was quoted as saying by Deutsche Presse-Agentur newswire. “The SPD won’t reject such talks.”

More than two months after an inconclusive election that brought a far-right party into parliament and was the CDU's worst showing since World War II, Merkel is still trying to work out how she can govern after her effort to forge a deal with three smaller parties fell apart on Sunday. Still, while Merkel remains skeptical about ruling without a parliamentary majority and the SPD leader Martin Schulz wants to avoid a formal coalition, the two sides are inching closer as they try to bring stability to the country.

Over the past few days, pressure has risen on Schulz to reverse his stance since the smaller free-market Free Democratic Party withdrew from coalition talks last week, plunging Germany into a rare bout of political uncertainty, as a repeat German vote is seen as the worst-case political outcome. As Bloomberg notes, "Schulz is facing calls by SPD lawmakers and state leaders to drop his refusal to join a Merkel coalition. Schulz favors pledging SPD support for a minority government, an arrangement Merkel wants to avoid. That arrangement might involve an SPD pledge to support Merkel on legislation on a case-by-case basis without joining her administration."

Seeking to reciprocate, and sensing the change in the political climate, senior members of Merkel’s party have doubled their efforts to bring the SPD back into the fold. Volker Kauder, head of the CDU-CSU group in parliament, told Germany’s Südwest Presse on Thursday that he would be happy “if the current partners in government found each other once again”. Mr Kauder pointed to the “special responsibility” of the country’s two biggest establishment parties.

Seeking to tame hopes that an SPD coalition is now a done deal, Manuela Schwesig, the Social Democrat prime minister of the eastern state of Mecklenburg-Western Pomerania, said on ZDF television that “for us it’s clear that if there are talks, then we will also take part in these talks, but added that "just because we’re saying that we’re open to talks, it’s not automatically a discussion about a grand coalition, and certainly not a vote for a grand coalition.”  She also stated that some in the SPD are asking “aren’t there alternatives to the automatic grand coalition or to new elections, are there alternatives in between?” Different things are under discussion and we’re saying that we have to talk about these different things now."

Furthermore, whatever the SPD decides, it will likely require the approval of members, Heiko Maas of the party leadership committee told ZDF television late Thursday. The SPD is holding a party congress in Berlin from Dec. 7 to Dec. 9, when Schulz will be up for re-election as chairman, and his political career is suddenly in doubt. Having led the SPD to its worst result since World War II in September, Schulz is under pressure from within his party to step aside, a move that might help clear the way for a grand coalition. Heil sought to quell the speculation on Thursday, saying “personnel matters” aren’t on the agenda for now.

On Thursday, Schulz met with German President Steinmeier as Germany’s head of state, a former SPD foreign minister, tries to secure a stable government. Steinmeier has made clear he wants to avoid new elections, and has urged party leaders on all sides to show flexibility and readiness to compromise.

Meanwhile, as they prepare to engage with Merkel, the Social Democrats are split between those on the left who see the two coalitions with Merkel as the main reason for the slump in its support and those who spy a chance to push through policies such as expanded health care and reaching out to French President Emmanuel Macron to strengthen the euro area, according to a Bloomberg wrap. Many in the SPD would prefer to stay out of government to prevent the far-right Alternative for Germany, which entered parliament for the first time with 12.6 percent of the vote in September, from becoming the biggest opposition force.

For now, the market is giving the latest developments the benfit of the doubt, and has sent the EURUSD up as much as 0.2% to 1.1875, its strongest level since Oct. 13; the pair climbs a fourth day, with the euro set for its best yearly performance since 2003.