What a Weakened Merkel Will Mean for the Euro Currency in the Coming Months

Following the result of the German election, the future now appears to be a little more uncertain for the euro.

Since markets opened Monday, the euro, a common currency, has been under pressure after provisional results revealed a weakened Angela Merkel and a rising far-right Alternative for Germany (AfD) party that earned its first seats in parliament. The currency dropped 0.6 against the dollar for the session, trading at $1.1872 at around 1:00 p.m. London time.

Traders appear to be divided when it comes to the performance of the euro in the near term. However, they point out that the European Central Bank (ECB) will ultimately remain to be the underlying factor for the currency.

“The reaction in the EUR and in the credit markets is predictable, but with the ECB still a powerful force in the European debt markets, the moves are unlikely to turn violent,” European head of FX strategy at BMO Financial Group, Stephen Gallo, said in a note.

Many traders were surprised by Sunday’s vote with a more fragmented German parliament. Christian Democratic Union (CDU), the centre-right of Merkel, and the Christian Social Union (CSU), its Bavarian sister-party won 33% of the vote, down from 41.5 percent in the previous election. Placing fourth 10.7 percent of the votes, the pro-business FDP party has said that it is open for talks of a coalition with Merkel’s CDU. The Greens are also set to participate in the coalition talks, which could ultimately form the first four-party government of Germany in decades.  However, talks of a coalition will not be easy. At the same time, the far-right AfD beat the predications of pollsters and received 12.6 percent of the vote share.

“This is a turning point in German politics, but nothing dramatic changes in the short-run as the coalition building process starts. The ECB is still on course to taper quantitative easing in the coming months, and the USD is still in a multi-month downtrend,” added Gallo from BMO.

Strategists believe that the vote is not going to change much of the political direction. However, they are divided when it comes to the currency’s performance against the dollar.

“We see the euro to trade sideways for a while as the USD rebounds from having fallen a bit more than was justified by the fall in real yields,” said the CEO of Tatton Investment Management, Lothar Mentel, to CNBC on Monday.

He added that despite the weaker voting totals compared to the previous election, the re-election of Merkel should not gratly change politics. “The main change should be an atmospheric one,” said Mentel.

On Monday, the global fixed-income strategist at Societe Generale, Kit Juckes, told CNBC: “It’s not a big (euro-dollar) move.”

Juckes said that the euro-dollar trade should hold around $1.19. However, if talks of the coalition in Germany drag on, the currency will move down further. “If it takes a very long time, that would be a good reason for the euro to drift lower over the course of this week,” continued Juckes.

The head of forex at Rabobank, Jane Foley, told CNBC: “On balance, we are of the view that EUR/USD could be choppy around current levels on a one to three-month view. While we are forecasting a move to EUR/USD1.22 on a 6-month view, European politics constitutes a risk to this outlook.”