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●   The Merkel approach pays off: Germany is weathering the COVID-19 crisis better than most other advanced countries. Luck plays a role. As the virus struck Italy, France and Spain first before it spread across Germany, Berlin had some advance warning of the dangers ahead. More importantly, Germany drew the lessons fast whereas the US, the UK and Sweden did not. With the calm, determined, science-based and non-partisan approach of Chancellor Angela Merkel, Germany flattened the curve at an early stage.

●   A reversal of fortunes: Six months ago, Merkel was little more than a lame duck. Having already announced in October 2018 that she would not run for a new term as chancellor, she had also ceded control of her CDU party to a would-be successor. Last December, her restless coalition partner SPD elected a left-wing leadership duo who toyed with the idea of leaving the government and bringing down Merkel in the process. Her power to shape events had waned.

●   A window of opportunity: Thanks to a surge in her approval rating and in support for her CDU/CSU, Merkel is now in the driving seat again. Instead of leaving the coalition, the SPD is working closely with Merkel to steer Germany – and Europe – through these unsettled times. But Merkel’s return to the pinnacle of power will not last. She will not run for a fifth term at the elections in September 2021. Her CDU will select a new leader in December. At that time or shortly thereafter, CDU and CSU will settle on a joint candidate to succeed Merkel as chancellor. He or she will then be in the limelight, not Merkel. To leave a lasting legacy, Merkel has to act before her power wanes again.

●   A time to make or break Europe: The next six months will be crucial for Europe. If the European Union fails to come up with a common response to the worst peacetime recession, a perceived lack of solidarity between the lesser-hit north and the worse-hit south could undermine the cohesion of Europe. In Italy and elsewhere, right-wing populists may garner more support for calls to leave the EU and the euro. However, if the EU can agree on the most impressive act of cross-border solidarity ever along the lines of the €750bn fund proposed by the European Commission, the EU and the Eurozone could emerge stronger than before from the crisis even if the proposal is watered down a bit.

●   No easy feat: Negotiations about the €750bn fund will be tough, especially with the “frugal four” led by Austria, which prefer a smaller loans-only facility. Many other countries have also raised objections in order to dip deeper into the pot. We expect some signal of common goodwill but no breakthrough yet at the 18-19 June EU summit. Although one or two special EU summits in July will likely make progress, it may take until late 2020 to hammer out the deal.

●   Weighing in: If Merkel can broker a deal, she will safeguard European integrity and leave a strong European legacy. For three reasons, her word will carry even more weight than usual in the next six months. First, Germany will hold the rotating presidency of the EU Council in H2 2020. Second, when money is the big issue, the role of Germany as the financial anchor of the European continent matters even more than usual, as it had done in the euro crisis. Third, because of her strong support at home, she can build a domestic consensus to be generous and take an enlightened long-term view rather than a more narrow and stingy approach. In the end, a little extra dollop of German money for the EU’s seven-year budget from 2021 to 2027 may help to seal the deal for a stronger Europe.

Holger Schmieding

Chief Economist

+44 7771 920377

holger.schmieding@berenberg.com

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This material is intended as commentary on political, economic or market conditions for institutional investors or market professionals only and does not constitute a financial analysis or a research report as defined by applicable regulation. See the "Disclaimers" section of this report.

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