The likeliest outcome in our view is a traffic light coalition. Scholz has recently said he would not countenance a leftward lurch under his chancellorship, though he admittedly did not explicitly rule out a government role for The Left party. Scholz is a middle-of-the-road politician, so a link-up with The Left is hard to envisage. The fact that he has not categorically rejected the possibility can be seen as a sop to the left wing of his own party. If the SPD does win the election, he can be expected to show his hand and come out more firmly against a left alliance. In any case, the differences between the SPD and The Left on defence and foreign policy present an almost insurmountable obstacle. The Left is opposed to NATO. It has recently signalled some flexibility on this point as the price of a place in cabinet, but it also opposes any increase in defence spending. The SPD, however, wants to modernise Germany’s armed forces, which could involve a bigger defence budget. Thus an alliance with The Left is intrinsically difficult.
The possibility of a new "grand coalition", that is, an alliance of CDU / CSU and SPD, is on shaky ground. Based on current surveys, there would theoretically be a wafer-thin majority for a new edition of the "Great Coalition". Germany has been governed by a grand coalition (dubbed a “Groko” in German) since 2013, but such an arrangement always looks like an emergency makeshift and is disliked by politicians as well as by the public at large. So a “Groko plus”, i.e. including the FDP, is also not viewed with favour by any of the chancellor candidates. The same goes for a coalition of the SPD, CDU/CSU and Greens (known as a “Germany coalition”). Here again the similarity with a grand coalition would be too strong.
What about the chances of the CDU/CSU forming a government without the SPD even if the latter emerges as the largest party? We can only see happening if a victorious SPD were to fail in its attempt to build a coalition. In that case the CDU/CSU might try to form a “Jamaica coalition” (black, yellow, green) by getting into bed with the Greens and the FDP.
Implications for the financial markets
As most elements of the political agenda are predetermined (notably the transition to green energy and accelerated digitalisation), we do not foresee any abrupt change of direction in German politics as a result of the election. The only outcome that would lead to a major policy shift would be a left-wing alliance including The Left, which would probably lead to a major expansion of the public sector, tougher regulation of corporations and the financial markets and rising government debt. This last point could bring Germany into conflict with the EU, paving the way for debt pooling and a destabilisation of the euro.
But if The Left is not brought on board, the election outcome is unlikely to have any significant impact on the financial markets. Priorities are already set in stone, fiscal room for manoeuvre is limited by the debt mountain resulting from the pandemic, and all the possible government participants are supportive of the EU and the euro.
The new government will face an almost unprecedented catalogue of challenges. The “to do” list will prioritise green energy transformation, digitalisation of the public domain and measures to deal with the consequences of demographic change. The objectives are agreed, and action cannot be postponed. Other policy goals will hardly get a look-in. German politics are therefore not on the verge of a major upheaval. However, with the departure of Angela Merkel the EU loses a powerful mediator and conciliator. Future conflicts will require increased cooperation between Germany and France. We do not expect the election to have significant consequences for the financial markets.