Can Merkel go it alone?

In a devastating blow for Angela Merkel, French presidential election favourite Francois Hollande's enthusiasm for renegotiating Europe's budget treaty could send her austerity efforts back to square one.

German Chancellor Angela Merkel may be close to scoring a major strategic coup in forcing Greece’s recalcitrant politicians to sign up to stringent budget cuts, but she’s becoming increasingly worried that France is about to fall off her austerity wagon.

Her biggest worry is the Socialist candidate, Franois Hollande, who at this stage looks almost certain to win the two-round presidential race in April and May, ousting the incumbent, Nicolas Sarkozy.

Merkel has two main fears. In the first place, Hollande’s plan to tackle soaring French unemployment by swelling the size of the public service is anathema to the thrifty chancellor, who is keen to see eurozone governments cut their spending.

In his manifesto, which was launched a fortnight ago, Hollande pledged to cancel €29 billion worth of tax breaks for the wealthy and to use the money to create 60,000 new teaching jobs, and 150,000 new state-aided jobs for youths.

What’s more, while most European governments are lifting retirement ages, Hollande bucked the trend and promised to cut France’s retirement age to 60. He also took aim at the banks, with a 15 per cent increase on bank profits and plans to force them to separate their traditional banking operations from "speculative” investment banking.

But even more worrying for Merkel is Hollande’s pledge to renegotiate her precious, prized treaty that will force all eurozone countries to follow a rigid budgetary discipline. Last month, Merkel – with the help of Sarkozy – scored something of a coup when she got all 17 eurozone countries to agree to her tough new budget rules, which for most countries will require major cuts in government spending and difficult tax hikes. Merkel believes that the new treaty has helped ease tensions in European financial markets, and is utterly dismayed to see that Hollande is threatening to undo all her good work.

In an interview with the French newspaper Le Monde, Hollande argues that it will be possible for him to renegotiate the treaty even if all eurozone countries have signed it. "This treaty will be signed on March 1, but I’m not sure that, by the month of May, it will have been ratified by more than one or two countries. If the treaty is signed but not ratified, we can renegotiate it,” he said.

Hollande told Le Monde that he wanted to make two changes to the treaty. In the first place, he wants to clarify the role that the European Court of Justice will play in ensuring that countries follow the tighter budgetary rules, and the type of punishment that will be given to countries that fail to prune their budgets.

But even more worrying for Merkel is the fact that Hollande wants the treaty to include a reference to growth and employment, such as allowing countries to borrow in order to fund major developments, especially industrial projects.

Hollande’s latest comments will be ringing loud alarm bells in Berlin. With many of the debt-strapped eurozone countries trapped in recession, the last thing that Merkel wants is for Paris to start spruiking a Keynesian-style 'borrow and spend' program.

Merkel has already made a controversial promise to back her friend, and fellow conservative, Nicolas Sarkozy in the French presidential elections. And Hollande’s latest comments will reinforce her determination to do what she can to bolster Sarkozy’s chances.

At the same time, she’s running the huge risk that she’ll only succeed in souring her relations with France’s next president, and that he’ll become even more determined to throw off Berlin’s austerity yoke.

InvestSMART FORUM: Come and meet the team

We're loading up the van and going on tour from April to June, with events on the NSW central & north coast, the QLD mid-north coast and in Perth, Adelaide, Melbourne, Sydney and Canberra. Come and meet the team and take home simple strategies that you can use to build an investment portfolio to weather any storm. Book your spot here.

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles