Amidst an exceptional turnout of 84% of the electorate, Germany has voted in a crucial election that will see Friedrich Merz become Chancellor.¹ Compared to last October, when it became apparent that an election would be called, the vote for the CDU/CSU is down slightly vis-à-vis the polls,² the AfD has not rallied as much as their admirers would have believed and the Sahra Wagenknecht Party and FDP failed to win enough votes to participate in parliament.³

The surprise has been the rise of the left-wing party, Die Linke, to whom voters likely shifted from the BSW party. At the regional level, there was a stark preference for the AfD in the ‘old East’ of Germany.⁴

The Franco-German engine is back in motion

Merz struck a forceful tone in the aftermath of the election, and we believe that this is a major plus for the EU. Merz is not as charismatic as Macron but broadly shares the same beliefs and pro-EU conviction. For the first time in over a decade, the French and German leaders share a vision and sense of urgency. The Franco-German locomotive is moving again, which is important in the context of major damage having been done to transatlantic relations in the past week by the Trump administration — a sign of this being comments from the Spanish foreign minister calling for a new approach to relations with China.⁵

Merz wants to form a coalition as soon as possible and needs to achieve several policy milestones.

On coalition formation, the easiest option is a partnership with the SPD, which would give a slight majority. In this context, Olaf Scholz would be unlikely to serve in such a government and would likely be replaced by Boris Pistorius — the current defence minister and someone who is on the same wavelength as Merz.

Forging a coalition with the Greens might be desirable in the long term, but it could drag out negotiations (Robert Habeck, who has a poor relationship with Merz, is leaving frontline politics, which helps). It may be that a voting arrangement is found with the Greens to secure their support for changing the Basic Law and thus the debt brake. Yet, together the CDU/CSU, SPD and Greens would still fall short of the 66% needed to change the Basic Law.⁶

Policy challenges 

Merz’s policy agenda will be a busy one — lowering personal and corporate taxes, cutting back regulation (i.e. planning) and implementing a tougher immigration policy framework. There is an obvious and well-documented need to spend more on defence and arguably an even greater need to renew infrastructure in transport and energy. Some of this could be achieved by recapitalising transport providers and national and state investment banks, i.e. KfW.

With an EU summit on defence spending to be held on 6 March (Merz will surely attend), there are a few options open to Germany to boost spending. One is to vote in a change to the debt brake (difficult given parliamentary arithmetic — there is talk of doing it in this parliament), declare an emergency event that merits high spending as was the case with COVID (it will be argued that President Trump has created a crisis) or for Germany to play an outsized role in underwriting European defence bonds.

Our sense is that the end of the troubled Scholz-led coalition could trigger an ‘animal spirits’ rebound in the economy. German bond yields may rise, and there is scope for the euro to halt its descent relative to the dollar. We also think that there is a good chance that ‘strategic autonomy’ sectors like defence, AI, quantum, and cyber, for instance, could see an investment uptick.

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