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Analysis: Europe braces for return of Germany's "Madame Non"

German Chancellor Angela Merkel casts her shadow on an European Union (EU) flag as she arrives for a news conference after talks with Yemen'
German Chancellor Angela Merkel casts her shadow on an European Union (EU) flag as she arrives for a news conference after talks with Yemen'

By Noah Barkin

BERLIN (Reuters) - German Chancellor Angela Merkel is hardening her stance on additional help for struggling euro zone economies like Greece and Spain as pressure from parliamentary allies and a looming election campaign shrink her room for maneuver in Europe.

At the start of the crisis, Merkel was derided by the French as "Madame Non" for refusing to approve quick aid to southern euro zone stragglers and rebuffing demands for sweeping solutions like common euro zone bonds.

Over the last year Merkel has softened that image with concessions and softer rhetoric. But growing unease among conservative lawmakers and the emergence of a new centre-left challenger points to a tougher line again ahead of a federal vote next year.

The announcement last week that Peer Steinbrueck, a combative former finance minister, will lead the opposition Social Democrats' (SPD) bid to unseat the chancellor in 2013 has swung Germany into election mode.

"We expect next year's federal election to start significantly narrowing the scope of political options in the near future," Alex White, an analyst at J.P. Morgan, wrote in a note this week. "We think we are coming towards the end of Germany's period of relative policy activism."

For Europe, this will mean an ultra-cautious approach from Berlin to providing further aid to Greece and Spain, and a go-slow stance on banking supervision.

"There simply isn't a majority in parliament for a third rescue package for Greece," Norbert Barthle, senior lawmaker and budget expert in Merkel's Christian Democrats (CDU), told Reuters. "We only just agreed a second package, and that isn't close to being exhausted."

Indeed, it looks like Germany's European partners will have to get used to more "nos", "nons" and "neins" from Merkel in the next twelve months as she seeks to consolidate her lead in opinion polls and win over critics in her conservative bloc.

The vote is a full year away, but Merkel, 58, will have to tread carefully against Steinbrueck, a candidate known for his fiery rhetoric and expertise on financial matters.

Until now, one of her biggest advantages had been a docile opposition that nodded through most of her government's euro policies with barely a whimper.

Those days are officially over, even if the SPD remains broadly supportive of Europe's bailouts.

SUPPORT FOR DRAGHI

Appeasing critics in her own camp is likely to become a full-time job for the chancellor in the run up to the election.

Many within Merkel's bloc, notably members of the Bavarian Christian Social Union (CSU), were troubled by her support for European Central Bank President Mario Draghi's new bond-buying program for troubled euro zone states over the summer.

That came after a string of compromises this year stirred unease in her coalition - from the decision to give Spain more time to meet deficit reduction targets, to signals that Merkel's government would tolerate higher inflation at home.

There was also her acceptance at a June EU summit in Brussels that Europe's new bailout fund be allowed to funnel aid directly to troubled euro zone banks.

In contrast to last year, the chancellor now talks frequently about the need for "more Europe". And doubts about her commitment to the single currency have faded.

A more delicate political landscape at home explains in part why Berlin is rowing back on the June summit deal - including the pledge to launch a new pan-European banks watchdog by January - and encouraging Spain to hold off on requesting aid.

One of the biggest challenges, for both Merkel and the wider bloc, will be Greece, the nation where the crisis first erupted.

Merkel's government has come full circle on Greece. After openly flirting with the idea of a Greek exit from the euro zone during the first half of 2012, her aides now say this would be disastrous and should be avoided at all costs.

But three years and two bailouts later, Greece's debt is still not on a sustainable path, and it is difficult to imagine its "troika" of international lenders skirting the need for additional relief in a new report, due next month at the latest.

Yet Merkel's allies in the Bundestag lower house have made clear they have been pushed to the limit of what they are willing to do for Athens.

LEGAL CHALLENGES, UNEMPLOYMENT

Merkel's preferred option - bundling more aid together with bailouts for Spain and Cyprus in one final pre-election package - carries big risks.

It is predicated on hope that all three of these deals can be agreed simultaneously, a dangerous assumption in a bloc where any one of 17 nations can hijack, delay or torpedo a rescue.

It would also put Merkel in the precarious position of relying on the opposition again, as a clear conservative parliamentary majority would by no means be guaranteed.

Merkel faces other challenges that will severely shrink her room for maneuver in the months ahead. Legal challenges to the ECB bond buying scheme are likely. And the German economy poses a growing threat, with unemployment creeping higher and recession possible in the second half of this year.

Despite a strong economic performance throughout the crisis, the gap between rich and poor in Germany has risen on Merkel's watch and polls show many voters are unhappy that banks have not been asked to pay a higher price for their role in the turmoil.

This is where Steinbrueck, who unveiled plans last week to crack down on the financial industry, will be looking to score big points against his former boss Merkel.

White of J.P. Morgan believes a more polarized political landscape will heighten Merkel's aversion to risk-taking and have a "chilling effect" on decision-making in Berlin. This will spell caution on new aid packages and put the brakes on plans for a new European banking supervisory body for two reasons.

First, Germany is interested in a sustainable, long-term solution on bank oversight that does not overload the ECB with new watchdog responsibilities in the short-term.

Second, Merkel remains skeptical about direct European aid for struggling banks and wants to avoid a discussion about the next stage of Europe's "banking union" - a pan-European deposit guarantee scheme.

Where does that leave Merkel and Europe? The answer - even more dependent on ECB President Draghi to bridge the yawning policy gap that looms in the run-up to next year's German election.

(Reporting by Noah Barkin, editing by Peter Millership)

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