The Euro bounced to a month high in the wake of the German elections, in apparent relief that the results are in line with what was expected from the polls. But, the gains could fade as forming a new government appears to be particularly challenging. Then there is the geopolitical impact with the new government vowing to pivot away from the US.
The center-right CDU/CSU union took the largest number of seats in the Bundestag, but at 28.6% was far short of the needed majority to form a government on its own. The results were highly fractured, with both the far right and far left parties gaining representation. The controversial far right AfD party scored the second highest results, doubling their vote share from the last election. But the other major parties have vowed to not work with them to form a government. With no two parties able to claim a combined majority of the votes, a three-way governing coalition seems inevitable, which promises to leave uncertainty and struggle to provide direction.
Flipping Places
The current Chancellor, Olaf Scholz saw his party lose the largest fraction of support ever. In fact, its electoral result was the worst since WWII. But the CDU’s results weren’t all that better. Although picking up votes, presumptive Chancellor Frederich Merz’s party had the second worst performance since the war.
Germany has been variously governed by coalitions of the SPD and CDU, with one leading and the other the junior party. However, those arrangements have been fairly unpopular, and both Scholz and Merz said they would not work with the other’s party if they won. But, now that the German elections results are in, it seems that Merz has changed his mind. After the AfD, the SPD is the largest party in parliament, and Merz said he would try to form a coalition of just two parties.
The Long Road to Negotiations
It seems, however, that the next government in Germany will have to be composed of parties that are ideologically at odds with each other. The last government collapsed for this reason, with the left-leaning SPD and Greens trying to work with the right-leaning FDP. The natural allies of the winning CDU this time around are the FDP. But adding them together doesn’t come close to the 50% needed to rule. Even a three-way CDU, FDP and SPD doesn’t make it over the threshold.
Merz has said he wants to form a government before Easter, and analysts agree that the negotiations will likely take a long time. That will leave Scholz still in charge of Germany in a caretaker position, leaving something of a power and leadership vacuum in a critical point for Europe.
The Shifting Tide
The prospect of a Merz chancellery has markets upbeat, since he’s expected to be more pro-business. This has helped support the Euro in the short term. On the other hand, he’s notably against reforming the debt brake, which would increase spending and likely raise interest rates. The gains in the Euro might not be long lasting as investors now focus on who will be in the new government and what that means for financial policy in Europe’s largest (and stagnating) economy.
Geopolitics were also an issue immediately after the election. Merz vowed to work on European integration and move away from the US. He railed at pressure from “both sides”, as in Moscow and Washington, over Germany’s policies. He’s also vowed to step up aid for Ukraine. But, all of that will have to wait until he can actually form a government.
