Ten Top Takes on the German election

The German Patient. The election to the Lower House (‘Bundestag’) of the German parliament on Sunday 23 February bears close watching in light of i) very poor German sentiment, amid 5 years of economic stagnation and perceived political paralysis, ii) the rise of non-mainstream party, including the far-right AfD and iii) the challenging geopolitical environment. Financial markets are also paying more attention to Germany, with German equities strongly outperforming and German bonds strongly underperforming G10 peers year-to-date. Here, we provide our top ten short-term perspectives to prep for the election.

1. Focus on the economy and immigration, as these are the top two topics for German voters, and the overall sentiment in Germany is poor. All of these are similar to the 2024 US election and point to strong anti-incumbency sentiment. But the major differences to the US election are that Germany has a parliamentary system, its politics are increasingly fragmented and German voters are more risk-averse, which implies less drastic political change in Germany than in the US.

2. Order of the Day. Final polls should be published at this point. No polls on election day until polling stations close at 6pm German time. During the day, there is usually an estimate of turnout by noon, but it is unclear how turnout (likely high) will affect prospects of different parties. At 6pm German time, exit polls are released by each of the two main public television broadcasters ARD and ZDF. These are usually pretty accurate (within 0.5-1pp of final result) and the average of the two is often an even better guide. However, the close nature of this year’s election (see below) implies there may be more uncertainty about the final outcome than usual even with relatively accurate exit polls. At 630pm German time extrapolations to results are usually available and by around 10pm a preliminary official result. First indications of coalition dynamics may also appear on the day on a live television round with the party leaders of all parties represented in the Bundestag at 815pm, even though it can be a little misleading given that impressions will be raw and there is likely post-election turnover in leaderships in one or more of the major parties.

3. Current standings: 1) On current polling, the centre-right CDU/CSU party is likely to win significant vote share (from 24% in 2021 to around 30%) and be the largest party in the next Bundestag. The CDU/CSU is Germany’s historically most prominent party, providing the three longest-serving German post-war Chancellors (including Angela Merkel) 2) The far-right AfD would be the second major vote-gainer (from 10% to 21%) ?and come second. 3) Those vote gains would largely come at the expense of current senior party in government, the centre-left SPD (from 26% to 15%), and its junior partner, the economically liberal FDP (11.5% to 4%, and therefore potentially failing to clear the 5% threshold to enter Parliament), while their other partner in the current three-way coalition government, the centre-left Green Party, looks to marginally lose support, too (15% to 13-14%). 4) Two far-left parties, the Left party (from 5% to 7%), and its offshoot BSW (newly created and polling at 4-5%), are also grappling with the minimum threshold for representation, with the Left Party ahead and also in contention to achieve three direct votes to enter Parliament regardless of the aggregate vote share. Less likely, the Free Voters are also aiming to enter the Bundestag via three direct mandates, 5) The Left Party has been marginally gaining in recent polls, and the CDU and most other parties losing some support, but overall polling trends have been stable, unlike in the 2005 and 2021 elections where polling trends changed considerably in the final two months before the election.

4. CDU-led base case with a positive policy impulse. It is highly likely that the CDU/CSU will lead the next German government, with its leader Friedrich Merz to be the next German Chancellor. Our base case, based on averaging the polls of the three most accurate pollsters for the last two German elections (FGW, Infratest and INSA), would be another ‘Grand Coalition’ with the SPD as policy positions are relatively compatible and it would be the only two-party coalition without the AfD that would have a clear parliamentary majority at 326 out of 630 seats (CDU/CSU and Greens would in the central estimation be exactly at 50% of seats). CDU/CSU, SPD and Greens would jointly have more than 2/3 of seats (67,3%), which would cross the supermajority threshold to amend the Constitution, including the ‘debt brake’ (discussed below). A Grand Coalition coalition would likely feature i) moderately looser fiscal policy, and ii) lower energy costs, and iii) maintain or extend recently tightened immigration policies – overall, it would be a rightward-shift in Germany not just compared to the last centre-left-led coalition, but also the Merkel-led coalitions previously. A CDU/CSU/Green coalition would involve some more ideological gymnastics, but would still imply a net business-friendly impulse and from a macro perspective included in our central scenario.

5. German polls usually fairly accurate, but the margins are very tight. Polling errors have been small in recent German elections (around 1pp per party), but the very small margins noted above imply that there are still various different potential outcomes. There also potentially many voters who are undecided who to vote for or to vote at all – up to nearly 30% according to one poll. There are no evident sources of consistent historical polling bias (eg around 'shy AfD voters'), but two issues of intense importance to watch are the potential for the CDU/CSU to underperform (in 2017, it underperformed every pre-election poll) and the possibility of the FDP and/or BSW to cross the 5% threshold to enter Parliament, given that they are currently less than 1pp below the threshold in our polling average. Those are the two issues to watch on election day, as CDU performance proxies for perceived business-friendliness of the next government and the number of parties entering Bundestag could lower the scope for fiscal stimulus, while both factors affect likely government stability.

6. The Alternative Scenarios for Deutschland. The margins are tight, both for the majority needed to form a government, and for the 2/3 supermajority. We therefore consider eight alternative scenarios, based on some combination of modest a) CDU underperformance, b) small party outperformance and c) including the other pollsters. These scenarios are subjectively chosen as plausible. They are virtually all as or mostly less benign from a markets perspective, despite the fact that variations assumed are modest (eg the CDU underperformance scenario is assumed to equate to its lowest rating among the 8 main German pollsters, which is roughly half its underperformance vs the polls in 2017, and other variations by party assumed are by 1pp of vote share or less). The key implications of the scenario analysis are: 1) the most likely governments would be i) Grand Coalition (in 2-3 out of 9 scenarios), ii) CDU/CSU/SPD/Green (in 4-5) and, iii) a three-way coalition including the FDP (in 1-2), with a chance of a CDU/CSU/Green government around the central scenario, as noted above too. 2) the vote share for a Grand Coalition ranges from 45.9-51.7%, and for CDU/CSU/SPD/Greens from 60-67.3%, implying that there would be a mainstream majority in all scenarios, but uncertainty over whether the supermajority threshold can be reached with mainstream parties only. There are three ‘shock’ scenarios that are not part of our 9 scenarios as they require much larger polling errors: i) Massive CDU underperformance (as in 2017) that could lead to a resignation by ?leader Merz, ii) a majority ‘on the left’ (SPD/Green/Left/BSW) whose vote share in our scenarios ranges from 38-45%, or iii) massive AfD outperformance – these would be major market negatives on Monday but we think still imply a mainstream government, even though a minority government or new elections cannot be entirely ruled out.

7. Patience. I expect 2-3 months for a coalition agreement to be negotiated. Historically, it takes at least a month for the government to be formed, but the length of negotiations has increased in recent elections. In 2017/18, coalition negotiations lasted five months. One month may be too optimistic given that enthusiasm will be low for any of the plausible party combinations to emerge, and because I expect one or more parties to look for new leadership post-election. The difficult economic situation and the urgency to get going argue against taking excessively long. Minority governments are possible in Germany, but are very unusual, and we think very unlikely in this election. Similarly, another round of elections because efforts to form a government failed is also very unlikely, and unprecedented in the post-war period, but cannot be ruled out entirely, as noted above.

8. Focus on fiscal. Market discussion has focused on the prospects for amending the German ‘debt brake’, which caps the cyclically-adjusted German budget deficit to 0.35% of GDP. Any change to the debt brake would require constitutional change, which in turn requires a 2/3 majority in both the Lower and the Upper house in Parliament, which is not guaranteed as noted above. We stress that: i) some fiscal stimulus is likely in most scenarios; even without a supermajority to change the debt brake, parties can still pass fiscal stimulus each year under an emergency budget, or ironically, through joint EU debt which is not covered by the debt break (even though both options may be constrained by the watchful Constitutional Court) ii) Fiscal stimulus is likely to be moderate even with a change in the debt brake or another multi-year ‘Special Fund’ (such as the EUR100bn fund for the military the German government passed in 2022), which also requires a supermajority. Various such options to be considered effectively imply at most 0.5-1.0pp of GDP in stimulus p.a., to be spent on defence, modest (household and/or business) tax cuts and some increases in public investment and iii) impacts on 2025 growth and issuance are negligible, given that at best stimulus will be enacted in time for H2, even though impacts would rise from 2026.

9. Far-right AfD strengthened but not strong. It is winning significant vote share, making inroads in the former West beyond its previous heartland in the former East and set to be the second-largest party in Parliament. It has become the largest party in some East German state elections and it is also finding more allies abroad, including in the US, Hungary and Spain. However, its immediate influence is limited post-election: it is extremely unlikely to be in the next government and will have limited influence on government policy even from the outside, even though it may complicate the path to fiscal easing. That would be true even in the very unlikely case that it became the largest party, but fell short of an absolute parliamentary majority. Even though the rise of the AfD in Germany, and the non-mainstream parties in Germany in general, is a major development and likely to be watched on Sunday, we think its near-term impact, including on markets, will be limited. However, the risk remains is that its influence will only grow over time, especially if mainstream parties fail to lift German sentiment during the next parliamentary term.

10. A very long to do list for the next German government, but progress uncertain: beyond i) fiscal policy (including tax cuts and raising public investment), the next government faces an unusually long list of high priority, and arguably urgent, policy issues: ii) increasing defence and security coordination with allies and raising defence spending. That may or may not involve some joint EU funding, but will not be part of a bid to increase political integration, iii) extending recent measures to tighten immigration or tightening them further in line with voter priorities, iv) responding to the threat of US tariffs, in part by holding out the prospect of larger purchases (in particular in energy and defence) but also potential retaliation in coordination with the EU, v) Support for Ukraine and relations with Russia, vi) how to lower energy prices and reinforcing security of energy supply, vii) China policy, as Germany veers between more hawkish policy, as Merz has advocated vs a less confrontational approach the EU Commission recently brought up as a potential option, viii) deregulation and reducing the burden of bureaucracy, ix) increasing incentives to work and tighten eligibility for social transfers, x) pension reform (even though it seems to have slipped off the agenda…).