The German election may fuel optimism about potential fiscal policy reform, which is expected to revitalise Europe’s largest economy. The euro and the DAX could strengthen further amid the projected result.
Both the euro and German equity markets are likely to be boosted by the outcome of the German snap election over the weekend.
The euro climbed to above 1.05, the highest in two months during Monday’s Asian session, while European stock markets are set to open higher according to futures pricing. Markets expect the result will lead to a favourable party coalition that accelerates economic reform and brings a pivotal change to Europe’s largest economy.
According to exit polls, the projected results from broadcaster ARD largely align with expectations. The centre-right Christian Democrats (CDU/CSU) won the most votes at 28.5%, followed by the far-right Alternative for Germany (AfD) at 20.7%.
Chancellor Olaf Scholz’s Social Democratic Party (SPD) is in third place at 16.5%, its worst result since the Second World War, while the Greens stand at 11.7%. The Free Democrats (FDP) and the Alliance Sahra Wagenknecht (BSW) won 4.4% and 4.9% of the vote, respectively, placing them on the brink of surpassing the 5% threshold required for parliamentary representation.
The winning leader, Friedrich Merz, stated that it was time for parties to hold talks and establish a new government by Easter, allowing political groups two months for negotiations.
A “grand coalition” scenario
While the final result will depend on inter-party negotiations, a likely outcome is a coalition government formed by the CDU/CSU and the SPD, possibly joined by a third party, the Greens. Such a formation is expected to pave the way for reforming Germany’s “debt brake”, a fiscal rule enacted in 2009 that limits government borrowing by capping the budget deficit at 0.35% of the country’s gross domestic product (GDP).
“Such an outcome is the most market-positive of all possible coalitions and is likely to result in a government being formed relatively quickly”, Michael Brown, a senior research strategist at Pepperstone in London, wrote in a note, referring to a coalition between the CDU and the SPD.
Germany’s economy contracted for two consecutive years in 2024, struggling with surging energy prices due to Russia’s invasion of Ukraine. Meanwhile, government spending constraints led to shrinking investment and limited military expansion, making Europe’s former economic powerhouse the laggard of the bloc. The new government will also need to address US President Donald Trump’s tariff threats and his calls for Germany to increase defence spending.
However, uncertainties remain, as the two minority parties are yet to secure their final results, while the far-right AfD may oppose fiscal reform. The new coalition must win two-thirds of parliamentary seats to secure a majority.
Euro and the DAX may see further strength
Both the euro and German stock markets are likely to see positive momentum in the short term amid election optimism, according to many analysts. The new government is expected to reboot Germany’s economy and attract more investment funds to the country.
The euro topped 1.05 against the US dollar last week ahead of the election. The common currency had plunged to just over 1.02 – the lowest since November 2022 – on 3 February, when Donald Trump announced his first set of tariff plans, including 25% tariffs on Mexico and Canada and a 10% levy on Chinese goods.
Despite the absence of direct export costs for the European Union, these tariffs significantly impact European businesses, which are widely exposed to global trade. However, the euro has strengthened since then, rising nearly 3% against the greenback, driven by Trump’s delay in implementing his tariff plans and a broad rally in European stock markets.
Germany’s stock market benchmark, the DAX, lost momentum last week after rallying 15% this year. The decline was triggered by Trump’s announcement of tariff plans on automobiles, pharmaceutical products, and computer chips.
A broad sell-off on Wall Street also weighed on European markets last Friday. Despite this, European equities have been outperforming their US counterparts, with notable gains in the defence sector.
Shares of Germany’s largest arms manufacturer, Rheinmetall, have surged 44% this year. Expectations of increased military spending by the new German government are likely to drive further gains in this sector.