Gerhard Schröder, the German chancellor, is the dead man walking of European politics. Germany's economy has been depressed for five years, with unemployment now at 12 per cent. His opportunistic anti-American election campaign in 2002 damaged traditionally good relations with the US. His instinctive corporatism and lack of leadership have greatly contributed to the European Union's present crisis. His one important political decision, the labour and welfare reforms launched in 2003, backfired because he could not explain them. Rarely in modern European politics has political failure been so profound and visible.

Tony Blair, the prime minister, and other leaders are right to look beyond Mr Schröder towards Angela Merkel, head of the centre-right Christian Democratic Union, as Germany's next leader. Her poll lead is unlikely to be overturned. The only question is whether the CDU-Christian Social Union grouping will win an absolute majority (probably not).

She stands for a more liberal, more transatlantic Germany. But it would be a mistake for US and UK policy strategists to get ahead of themselves in assessing the consequences of a Merkel victory. She will probably not turn against Jacques Chirac, the French president. Nor will she entertain the idea of a strategic Anglo-German alliance. So what should we expect?

Like many opposition leaders, she is much clearer on domestic than foreign policy. She is often compared to Baroness Thatcher, the former British prime minister. There are some striking similarities. They are scientists, unusual for top politicians in either country. Lady Thatcher is an Oxford-educated chemist. Ms Merkel holds a PhD in physical chemistry and has published in journals such as Molecular Physics and the Journal of the American Chemical Society.

The daughter of a Protestant priest, Ms Merkel grew up in Brandenburg, east Germany. Unlike most of her peers in the CDU, her political life started with German unification. She pays lip service to Germany's social market economy but often argues outside its framework. She is one of a rare breed of German politicians capable of using the word "freedom" without embarrassment.

But Thatcherites should not count her as an honorary member. Ms Merkel never tires of pointing out that Lady Thatcher opposed German unification, which has been the raison d'être of Ms Merkel's political life.

Unlike Mr Blair, Ms Merkel opposes Turkish membership of the European Union. Her views on this are said to have hardened since the No votes in the French and Dutch referendums on the European constitution. It is also an issue on which she is at odds with the US. But she will accept the commitments that the EU has made to Romania and Bulgaria and she also supports EU enlargement to the western Balkans.

Under Ms Merkel, Germany would maintain its close relationship with Mr Chirac, but this relationship would become less exclusive. In particular, I would expect Germany to return to a diplomacy it perfected in the past - forging strategic relationships with smaller EU countries. Again, this is different from Mr Blair, who is not known for his respect for little European states and their leaders.

But the make-or-break issue of her government will be economic reform. For the first two years of her term, support from the liberal Free Democrats should allow her a majority in both the Bundestag and the Bundesrat, the two chambers of parliament. A stable "double majority" is quite rare in German politics and is a window of opportunity to launch unpopular reforms, especially in the labour market. When Mr Schröder came to power he also had a double majority but did not use it. When Ms Merkel said last week that Germany's social and welfare system was no longer sacrosanct, she signalled that she might, after all, go for radical reform.

We should not take this reform programme for granted. There is vigorous opposition within Ms Merkel's party to some proposals, such as fundamental reform of health insurance, relaxation of hiring and firing laws and abolishing the wage cartel between employers and trade unions. I suspect Germany will also abandon its ridiculous restrictions on shopping hours.

Ms Merkel's liberalism ends with immigration. There is no chance that, under her government, Germany would open up its labour market to immigrants from the new EU member states ahead of time. Nor should one expect Ms Merkel to back Mr Blair's position on the British rebate in the EU budget and his decision to link debate of the rebate with reform of Europe's Common Agricultural Policy. There is considerable support for the CAP from sections of the CDU and especially the CSU, its Bavarian sister party. Unlike Britain, Germany will not go back on its commitment to France to let the CAP run until 2013.

Ms Merkel is a liberal, a transatlanticist and a pro-European and does not easily fit existing categories in the European debate. I would expect much better relations with Britain and the US but the change would be more one of style than substance. What makes a Merkel government potentially exciting is the chance of genuine economic reform. It would allow her to lead the Franco-German alliance - and with it the EU as a whole - in a new direction.