German election - A positive outcome for markets and the economy

The German election makes a two-party government between the conservative CDU/CSU and the Social Democrats (SPD) the most likely result (75%), which is a positive outcome for the German economy. Markets have also reacted positively to the news by strengthening the euro by 0.6% during Asian trading hours while DAX futures have climbed 1.1%. The conservative chancellor Friedrich Merz is certain to become the next chancellor as his party emerged as the biggest one with 28.6% of the votes. A majority government with the Social Democrats is possible because two parties fell below the 5% threshold for entering the parliament, namely the FDP at 4.33% and the BSW at 4.97%. This gives 328 seats to the CDU/CSU and SPD, above the 315 needed for a majority. A two-party “Grand coalition” government is a positive outcome because decision making is easier than in a three-party government. A new government will likely take office in two months’ time.

The far-right Alternative for Germany (AfD) became the second largest party with 20.8% of the votes, which is double the votes it got in the last election but at the same time in line with election polls. Being the sole party who has certainly refused to change the constitutionally enriched “debt brake” to allow more debt we see the chance of a reform being 60%. Such a reform requires a two-thirds majority and the CDU/CSU, SPD, Greens, and The Left have 76% of the votes. The reform will depend on the CDU as they have given mixed signals, which is the reason we estimate 70% chance of it happening (see next page for details).

In terms of defence spending and support for Ukraine, the election outcome was not the best scenario because the far-right (Afd) and the Left party combined secured 34.3% of the votes. Therefore, they will be able to block off-budget defence funds and legislation that requires two-thirds majority. Yet, with a less fragmented Parliament and a two-party government Germany’s presence in the EU will likely be stronger compared to the previous government, which is positive news.

Because the majority for a “Grand coalition” is so slim (13 seats) Merz might want to include the Green party in a coalition to not be pressured by SPD the members who are the least aligned with his policies, so it is 75% certain that we get a Grand coalition and 25% chance of a “Kenya” government. Since the BSW came so close to the 5% threshold there will likely be a recount of the votes to make sure the preliminary result is correct. We must wait for that before the results are 100% final.

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