Elections in the Eurozone’s biggest member state Germany are likely to be the most prominent political event in Europe in the second half of this year.

Angela Merkel, arguably the most powerful politician in the EU stands for re-election for a third term on September 22. She hopes to continue the current coalition of her conservative Christian Democrat Union (CDU) with the pro-business liberal democrats (FDP). Competing with her is Peer Steinbrück of the center-left Social Democrats (SPD), who was also finance minister in Merkel’s government. His preferred coalition partner are the Greens.

“Angie,” as Merkel is affectionately known, is hugely popular, but her party less so. Opinion polls now see a neck-and-neck race between Merkel’s coalition and the combined opposition, with recent momentum in favor of the Chancellor.

The most likely election day scenarios are (1) the continuation of the current government (we think 50% chance), (2) a grand coalition of the CDU and the SPD with Merkel as Chancellor, as in 2005-2009 (30%) and (3) the scare scenario of SPD and Greens teaming up with the former communist Left Party (10%. The remaining 10% probability we attach collectively to various other coalition scenarios involving the mainstream parties).

Wide consensus on Eurozone issues

The election is important for Germany’s economic future, as the parties diverge widely on important issues such as taxation. But global investors will rightly be much more concerned about the potential impact on future Eurozone policies.

Germany’s parliament (Bundestag) and the European Central Bank have proved to be the key back-stops of the Eurozone. When ECB president Mario Draghi announced on July 26,  2012 in London that the ECB would henceforth stop bond market panics in reforming Eurozone countries, it was rightly touted as a turning point of the Eurozone crisis.

Similarly, when Merkel traveled to Greece that October, she signaled that she had made up her mind to do everything necessary to keep Greece in the euro and soon ended speculation about a first country exiting from the Eurozone. That further stabilized confidence in the euro’s future.

Germany’s parliament is crucial. It has the power to bring down the euro by denying countries support. The ECB has reinforced this power by designing its safety net in a way that codifies the mutual dependence between itself and the Bundestag. To avoid that the crisis countries would stop economic reforms, the ECB has tied its bond purchase commitment to one condition: any benefiting country first needs to obtain financial support from the Eurozone’s ESM bail-out fund.

That requires the consent of all Eurozone countries including, crucially, the approval of the Bundestag. On the one hand, if Germany’s skeptical parliamentarians are not satisfied with an applicant country’s reform progress, they can reject bail-out requests and thus prevent the ECB from buying bonds. This is what some anti-Euro activists hope to exploit. On the other hand, with the support of the ECB’s theoretically unlimited firepower, Germany’s Bundestag has a better chance to bail out any Eurozone country, even Italy.

Three key issues

So what will happen after the elections? Four key hopes or fears are on many investors’ minds:

Is there a risk that Germany’s new Bundestag will reject future aid requests? No. At each of the previous 12 votes on Eurozone rescue issues 80-85% of the parliamentarians voted in favor.

CDU, SPD, FDP and Greens have always supported the rescue strategy and the bail-outs. Only a few rebels, mainly in Merkel’s coalition, and the “loony” Left party have consistently said “nay.” The center-left parties have often criticized the bail-out conditions as too harsh and entertain ideas of modest debt sharing, but when push came to shove, they always voted with the government.

Will Germany’s new Bundestag agree to Eurobonds?

A resounding “No.” Merkel and her center-right coalition are fiercely opposed to Eurobonds or any other form of debt sharing in the Eurozone. Eurobonds would destroy market discipline for Eurozone governments and are extremely unpopular with the German electorate. The center-left might be more sympathetic, but the unpopularity of Eurobonds holds for their electorate as well.

Even a left-wing government could not go very far as the center-right opposition would exploit the inevitable public backlash, for instance in the next regional elections. Moreover, Eurobonds would almost certainly require constitutional changes, for which a left-wing government would need a skeptical center-right opposition. Never say never, but the probability of Eurobonds is practically zero.

Will Germany’s new Bundestag accelerate the cleaning up process in the Eurozone’s banking system? Probably not. With the worst of the sovereign debt crisis behind us, attention has focused on the incomplete cleaning up of Europe’s banks.

Many analysts fear that an unstable banking system will weigh on the recovery. They fear that the much anticipated asset quality review of the European banking sector by the ECB in the coming winter will lose its bite unless the Eurozone complements it with a large financial back-stop that could immediately recapitalize banks if needed. Many believe that the €60bn set aside by the Eurozone’s rescue fund ESM is not enough, so that the review will be fudged.

Whether the capital injection is really as large as feared or not, none of the parties mention it in their programs. That entertains hopes that post-election Germany would accelerate the process and make more money available. But while the bank recapitalization might be a slightly easier sell for any new government than Eurobonds, it has become commonplace among German policy makers that the private sector should try to stem the recapitalization needs first. Unless the Eurozone falls back into recession, any new government is likely to give Europe’s banks ample time to strengthen their capital base.

Will Greece get further debt relief?

Maybe later. No party mentions it in the election manifesto, but keeping Greece in the euro is consensus. At the same time, mistrust remains widespread on both sides of the political spectrum and in the electorate. Small steps like loan extensions and interest rate reductions for Greece can be sold to voters, but a major reduction of Greece’s nominal commitments would require a little miracle. A center-left government would be more likely to go down this route than Merkel’s current coalition.

A non-event for Europe

In summary, while any new German government may be relieved of some of the electoral pressures, key positions will not change because they are in Germany’s national interest. Keeping the Eurozone intact is consensus. If re-elected, Merkel’s current coalition would not change its policy of mild skepticism vis-à-vis the Eurozone partners.

Help is extended if needed against tough conditions. Any involvement of the left-wing opposition would make life slightly easier for the current and future aid recipients. That should relieve investors in the short-term and compensate disappointment over a potential defeat for Merkel.

But Eurozone debt sharing remains politically near impossible and, in our view, rightly so. Keeping market discipline is crucial for the Eurozone to play out its strengths. With an ECB safety net, that is.

Dr. Christian Schulz joined Berenberg Bank in London as a Senior Economist in April 2011. He covers the Eurozone economy, the ECB, the German economy and global economy. Prior to Berenberg, he worked as an economist at the European Central Bank from 2008 to 2011, mainly in the Directorate General Payment Systems and Market Infrastructure. From 2003 to 2008, Christian was a consultant at The Boston Consulting Group in Frankfurt and Hamburg, Germany, where he was part of the Banking Core Group. Christian holds a doctorate in macroeconomics from the University of Hamburg. Read more articles by Christian.