World Crisis Online

Angela Merkel, Germany’s chancellor. Photographer: Jochen Eckel/Bloomberg

  Play Video Feb. 21 (Bloomberg) — Andrew Bosomworth, a fund manager at Pacific Investment Management Co., talks about the loss by German Chancellor Angela Merkel’s party in Hamburg state elections and the implications for bond markets. He speaks from Munich with Francine Lacqua on Bloomberg Television’s “On The Move.” (Source: Bloomberg)

Chancellor Angela Merkel’s party suffered its worst defeat in Germany’s richest state since World War II, the first of seven state elections this year that threaten to limit her scope to tackle Europe’s debt crisis.

The loss in Hamburg, the city-state of Merkel’s birth, underscores the challenge she faces trying to balance public opposition to bailouts for debt-wracked states against pressure from investors and fellow euro countries to lead the way in stemming the debt contagion. Merkel faces three more state ballots next month either side of a March 24-25 European Union summit called to form a comprehensive plan for the crisis.

“It’s a warning to Merkel,” said Carsten Brzeski, an economist at ING Groep NV in Brussels. “If she has to draw any lesson, it probably will be to get tougher at the European level to show something to German voters,” he said. “There is no room for Merkel to come home from Brussels on March 25 with anything that could look or smell like a defeat.”

Portuguese government bonds declined for a second week before the vote, leading securities of high-deficit countries including Greece lower. The 10-year yield dropped 2 basis points to 7.22 percent at 3:10 p.m. in Berlin today, holding above 7 percent for the 12th trading day in a row.

Peripheral Bond Risk

“There’s a risk to peripheral bonds if Germany is seen not to be displaying support for the countries that are in trouble,” said Orlando Green, assistant director of capital- markets strategy at Credit Agricole Corporate & Investment bank in London. “The market would have been hoping that a deal would have been struck already” before the elections.

Merkel’s Christian Democratic Union took 21.9 percent in yesterday’s election, its worst result in the port city since the first postwar vote in 1946 and half its score in 2008, preliminary results showed. The Social Democrats, the main national opposition party, took 48.3 percent, enough to end the CDU’s 10-year rule in Hamburg and form a majority government without need of a coalition partner.

“We have to acknowledge that this was a stinging defeat,” Merkel told reporters in Berlin today. Outgoing CDU Mayor Christoph Ahlhaus said the results were “painful,” and congratulated his Social Democratic opponent Olaf Scholz, a former Labor Minister in Merkel’s first-term government.

‘Massive Collapse’

The CDU suffered “a massive collapse of support in this booming city that must set off hand-wringing in Berlin,” said Hans-Juergen Hoffmann, managing director of Hamburg-based pollster Psephos. “Merkel will surely be concerned now that this disaster won’t be repeated in upcoming state elections.”

German state ballots follow in Saxony-Anhalt, Bremen and Mecklenburg-Western Pomerania, home to Merkel’s electoral district, and culminate in Berlin in September. A double-header looms next month in Rhineland-Palatinate and Baden-Wuerttemberg, the southwestern state ruled by her party for more than half a century. Both votes are on March 27, two days after the EU summit, in a “Super Sunday” for Merkel, Brzeski said.

In Hamburg, the Greens took 11.2 percent and the Free Democrats, Merkel’s national coalition partner, 6.6 percent, enough to win seats in the state parliament for the first time since 2004. The anti-capitalist Left Party won 6.4 percent.

Greece Blame

Hamburg was the first electoral test of Merkel’s policy since her party lost a state election last May, a result that she blamed on voter anger over bailing out Greece. The defeat cost her control of parliament’s upper house in Berlin, the Bundesrat, where regional administrations are represented. The Hamburg result, if confirmed, would cost the CDU 3 seats in the Bundesrat, further limiting her ability to pass legislation.

Merkel’s main European policy challenge this year is getting the EU debt-fighting deal through parliament and “for her, Baden-Wuerttemberg is the test,” said Holger Schmieding, chief economist at Joh Berenberg Gossler & Co. in London.

Germany, Europe’s largest economy, is already the biggest country contributor to last year’s 110 billion-euro ($151 billion) bailout of Greece and the rescue fund for debt-stricken states.

Merkel’s room to maneuver is also curtailed by her FDP coalition partner as it seeks to counter waning support. The FDP resists any attempt to top up the rescue fund, make it more flexible or relax the terms of bailout aid. It also insists that parliament has a say in any attempt to provide more aid.

While the CDU “can live” with the defeat in Hamburg, “for the FDP, it’s a good result after some very weak opinion polls,” said Schmieding. “A party less wounded is more able to make a deal.”

The Christian Democrats went into the Hamburg vote after a spate of negative headlines for Merkel. Axel Weber, her candidate to be the European Central Bank’s next head, dropped out of the race on Feb. 11 in what the best-selling Bild newspaper called “a blow to the chancellor and to the euro.” Defense Minister Karl-Theodor zu Guttenberg, Germany’s most popular politician, is denying allegations that he stole parts of his doctoral thesis.

To contact the reporters on this story: Tony Czuczka in Berlin at aczuczka@bloomberg.net; Brian Parkin in Berlin at bparkin@bloomberg.net.

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net