After the collapse of German coalition talks last week, the euro took the news in stride. At the time, we wrote that strong GDP growth is the primary driver behind the ongoing euro bull market. Despite the obvious significance of political instability in Germany, the most important economy in the Eurozone, the impact was unlikely to be felt in the short-term. While EUR/USD ended the day weaker (around 1.1740), the currency pair has since strengthened beyond 1.190 as of today. Looking at the future outlook of the euro, the latest news regarding another potential ‘grand coalition’ between the CDU/CSU and SPD is supportive for the currency. Beyond German politics, key drivers of the euro suggest that the medium-term outlook remains bright.

Eurozone politics: a tailwind?

The SPD’s recent announcement that it is willing to entertain coalition talks with Merkel’s CDU/CSU party is a remarkable change from its earlier position. Following the elections, SPD leader Schulz repeatedly denied the possibility of another grand coalition. More specifically, he claimed that the outcome of the vote represented the German electorate’s rejection of the previous coalition government. Following pressure from German President Steinmeier (a member of the SPD and a former minister in Merkel’s government), Schulz appears to have relented. While both Merkel and Schulz were calling for new elections last week (polls suggest a majority favor snap elections), another grand coalition is looking more likely today.

While the formation of another ‘grand coalition’ is far from certain, it would be supportive for the euro. This is because a coalition government including the SPD is more likely to support deeper integration with the EU. Unlike the FDP, the Social Democrats are supportive of ideas such as an EU finance ministry (with a dedicated budget) to coordinate economic policy. As Merkel becomes a weaker force in German politics, Macron’s push for deeper integration amongst EU members is looking more and more likely. Once a headwind for the euro, politics may become a tailwind.