May 7 (Bloomberg) -- Voters in Greece and France challenged austerity as Europe’s sole prescription for the financial crisis, adding pressure on German Chancellor Angela Merkel to broaden her focus from debt reduction to save the euro region.
Greek elections left the two biggest parties short of the clear majority to keep bailout efforts there on track. In France, Socialist Francois Hollande defeated President Nicolas Sarkozy, Merkel’s preferred partner for enforcing fiscal rigor.
“Europe is watching us,” Hollande, 57, told supporters in the central town of Tulle 90 minutes after his victory was announced. “The mission is now mine, to give European construction a growth dimension. That’s what I’ll tell our partners as soon as possible.”
Germany and France, whose leadership in fighting the crisis that began in Greece in 2009 gave rise to the partnership known as “Merkozy,” don’t have much time to patch up rifts between Merkel and Hollande.
“To get anything done in Europe, Germany and France have to agree,” said Holger Schmieding, chief economist at Berenberg Bank in London.
The euro fell to a three-month low in Asian trading after the elections, declining to $1.2955, the weakest since Jan. 25, before trading at $1.3048 as of 3:51 p.m. in Berlin. French government bonds reversed earlier declines, pushing the 10-year yield two basis points lower to 2.79 percent.
“What worries me is the initial negative reaction in the Asian market,” said David Kotok, chief investment officer at Cumberland Advisors. “Political turmoil raises the uncertainty premium.”
Hollande’s platform calls for policies Merkel opposes, including higher taxes, increased spending and a delayed deficit-reduction effort. He used his campaign to call for an activist European Central Bank, defying Germany. He also sniped at Merkel’s policies by calling for watering down a European Union accord that she pushed to cut debt.
The fiscal pact “is not up for debate,” Merkel said in Berlin in her first response to Hollande’s election, while rejecting debt-financed government stimulus programs in favor of “sustainable” means to bolster growth.
As Europe’s economy stagnates and unemployment climbs, an opposing view is gaining momentum. Unemployment in the 17-nation euro region rose in March to 10.9 percent, the highest in almost 15 years. Spain is struggling to convince investors it can avoid a bailout and the government of the AAA-rated Netherlands fell last month amid the effort to deepen deficit cuts and meet European targets.
Underscoring the shift, EU Economic and Monetary Affairs Commissioner Olli Rehn indicated on May 5 the bloc would show flexibility in enforcing its deficit rules.
For much of the electorate in Greece, in a recession since 2008, tweaks to the rules don’t go far enough. Projections early today showed the two main parties, which would form a coalition to enact agreements with international creditors, falling short of a majority in the 300-seat parliament.
‘Worst Possible Scenario’
That’s the “worst possible scenario,” Athanasios Vamvakidis, head European currency strategist at Bank of America Merrill Lynch in London, said in an e-mail. “Political paralysis is now a clear risk in Greece, with very negative implications for the rest of the euro zone if Greece is threatened by an exit from the euro.”
For Greece’s paymasters, bond yields suggest investors expect Hollande and Merkel to do what’s necessary to maintain market confidence. Ten-year French debt yields 124 basis points more than comparable German securities. That’s down from 145 basis points after Hollande won the first round on April 22 and lower than the 133 basis points at the start of the year.
Merkel doesn’t need to compromise because Hollande “is going to be forced to climb down due to France’s weak economy,” said Fredrik Erixon, head of the European Centre for International Political Economy in Brussels.
France lost its AAA credit rating at Standard & Poor’s this year. The German jobless rate of 6.8 percent, a two-decade low, compares with almost 10 percent for France. French gross domestic product grew 1.7 percent last year while German GDP expanded 3 percent.
“Merkel is just going to lean back and watch Hollande jump into the icy water and try to swim,” Erixon said by telephone. “He’ll soon realize his predicament, because financial markets are going to do to France what the French electorate didn’t do. Investors can handle good or bad news, but they hate uncertainty.”
For all their differences, German and French leaders of opposing political camps have a history of cooperation. The two nations, former enemies that fought three wars between 1870 and 1945, were founding members of the EU that was created to make military conflict between them impossible.
Social Democrat Helmut Schmidt and Valery Giscard d’Estaing gave impetus to the Group of Seven in response to the 1973 oil crisis. Christian Democrat Helmut Kohl and Socialist Francois Mitterrand clasped hands at the World War I battlefield cemetery of Verdun in a gesture of reconciliation. Social Democratic Gerhard Schroeder and Gaullist Jacques Chirac found common cause in opposing the U.S.-led invasion of Iraq.
It took the threat to the euro for Merkel and Sarkozy to form a united front.
“French and German leaders from different political poles have always been a good match,” said Carl Graf von Hohenthal, a management adviser at the Brunswick Group in Berlin. “Merkel and Sarkozy were from the same political family and it was no love fest. Hollande will be 100 percent more reliable for Merkel than Sarkozy was.”
Merkel called Hollande last night after his victory and invited him for talks in Berlin as soon as possible, saying that he “will be received in Germany with open arms.” It was the first time she could recall them having spoken, she said.
“Both are pragmatists,” said Volker Perthes, head of the Berlin-based German Institute for International and Security Affairs, which advises the government. “They will find consensus.”
Hubert Vedrine, a former French Socialist foreign minister, said there won’t be any “honeymoon” for both leaders and that he expects Hollande to moderate his demands.
“There will be compromises,” he said in an interview. “We can expect a serious dispute, because their positions are very different, but by fall we can expect an accord.”
Even before the vote, German Finance Minister Wolfgang Schaeuble signaled a willingness to avoid a head-on clash, while he drew a red line for Hollande.
“We’ve told Mr. Hollande that the fiscal pact has been signed and that Europe works along the principle of pacta sunt servanda,” meaning agreements must be kept, Schaeuble said in a May 4 speech in the western German city of Cologne.
“I’ve said that everybody who gets freshly elected into office must be able to save face,” Schaeuble said. “So we will discuss this with Hollande in a very friendly way. But we won’t change our principles.”
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