On February 23^rd, after a particularly heated election campaign, Germany will elect a new parliament in an election process that is itself more complex than in most countries. The balance of power that emerges between the many different parties will be crucial to the formation of what is likely to be a new coalition government. The coalition that governed until November 2024 fell apart, not least over economic and fiscal policy. The formation of a new government is likely to involve policy negotiations between the parties – which could progress rapidly if the election produces a clear winner but may be protracted if it does not. It could take months for a new policy agenda to be formulated.

The election is the starting point for our analysis. We then look at why the German economy has been struggling in recent years and to what extent an improvement may be possible after the election. What are the parties' proposals for strengthening the German economy, and which have most chance of being implemented under different political constellations? And what does all this mean for German financial assets and for investors?

1 / Germany’s electoral landscape

1.1   More parties may enter the Bundestag this time around

In the imminent elections many parties are vying for the right to influence Germany’s political future. Leading the polls now are the Christian Democratic Union (CDU) and its Bavarian sister party, the Christian Social Union (CSU). Together they are known as the Union parties – and we will refer to them collectively as the Christian Democrats. They represent the center-right in Germany, and traditionally emphasize economic stability, national security, and a strong European Union (EU). Both the CDU, founded after World War II, and the Social Democratic Party (Sozialdemokratische Partei Deutschlands -- SPD), which was established in the 19^th century and has its roots in the labor movement, have historically been the only parties to nominate the chancellor. The SPD is a center-left party which has been a longstanding advocate for social justice, labor rights, and strengthening of the welfare state. Meanwhile, Alliance 90/The Greens – commonly referred to as just the Greens – have their roots in the environmental movement of the 1980s and prioritize environmental issues, sustainability, and social equality. The Alternative for Germany (AfD), founded in 2013, in part in response to the Eurozone crisis, is a far-right party that has gained traction through its populist rhetoric and criticism of immigration policies and the EU.

Alongside these major players, numerous smaller parties are also competing for influence in shaping Germany's political future. The Free Democratic Party (FDP), founded in 1948 with the primary aim of rebuilding Germany's economy, is known for its liberal economic policies, championing of individual freedoms and commitment to a free-market economy. Die Linke (The Left), which has its origins in the Party of Democratic Socialism in the former East Germany, stands for democratic socialism, anti-capitalism and pacifism, and appeals to voters on the far left. Then there is “Bündnis Sahra Wagenknecht” (BSW), a party recently founded by the former deputy leader of The Left, Sahra Wagenknecht, which combines left-wing populism on economic issues with cultural conservatism. Lastly, the Free Voters (Freie Wähler, FW), not a traditional party but a loose association of independent voters and local politicians, focuses on grassroots democracy, decentralization and community-oriented policies; its stance on political issues often varies across different regions.

1.2 Polling and the campaign so far

Attacks by migrants have made the migration question the primary topic in campaigns

Germany has been going through one of the most momentous election campaigns in living memory. A number of fatal stabbings and other assaults by migrants, most recently in the city of Aschaffenburg in January, have caused widespread alarm and further increased the importance of migration as an election issue in the final weeks of the campaign, triggering high-profile debates in parliament.^[1]

The previous government, led by chancellor Olaf Scholz, was unpopular and the Ampel or “traffic-light,” coalition, based on the colors of the parties involved, the Social Democrats (SPD), Greens and Free Democrats (FDP), collapsed spectacularly in November amidst mutual recriminations. The center-right Christian Democrats, the biggest opposition party, might have been expected to benefit. But looking at polling data it is striking that the CDU and CSU, have, if anything, been losing ground since the collapse of the previous government. This is a highly unusual development, perhaps reflecting lingering doubts among some voters whether they want Christian Democrats back in government so soon. It may also be that voters distrust all the major parties, feeling that none has successfully addressed the problems the country faces. Prior to Scholz’s period as Chancellor, the Christian Democrats were in power for 16 years during which reforms were delayed as the economy seemed to be doing fine. Since then, it may have become clear to some voters that many structural problems predated the Ampel. The Christian Democrats’ previous openness to migration may also have cost it popular support, and the AfD has been able to profit from that.

National polling averages show modest but potentially significant changes since new elections were announced

Source: Simple averages created based on data from wahlrecht.de as of 01/31/2025

Too early to call the impact of recent parliamentary maneuvering

The polling data is inconsistent and suggests many voters remain undecided – and therefore open to being persuaded by one party or another. For example, the simultaneous findings of normally quite reliable pollsters show a CDU/CSU support at anywhere between 28% and 34% -- an unusually wide range.^[2]

Up until the fatal stabbing in Aschaffenburg, in which a man and a 2-year-old boy were killed, the Christian Democrats had attempted to talk as little as possible about migration, presumably because the party felt that its economic policies would be more likely to draw support from its target electorate. Friedrich Merz, their candidate for chancellor, also tried, not always successfully, to avoid any collaboration with the far-right AfD, including at the local and regional level. But, in the final days of the current parliament, the Christian Democrats joined forces with the AfD and Free Democrats (FDP) to pass a non-binding resolution on migration in the Bundestag.

This joint vote was extremely controversial because it arguably breached the so-called “Brandmauer,” or firewall – a determination on the part of all centrist parties that they would not collaborate with the extreme right, especially at the national level. This led to an intervention in the debate by the former chancellor and CDU leader, Angela Merkel, at the end of January in which she criticized Merz and said it was wrong for the CDU to do this.

A later attempt to pass an actual migration law (at least through the lower chamber) failed, but not without further highlighting divisions among the Christian Democrats. Although Merz has gone out of his way in recent days to paint the AfD as an unacceptable partner for any governing arrangement, we expect the Christian Democrats to continue to be dogged by questions about the party’s flirtation with the far right.

1.3 How polls translate into majorities

A complex system, in which smaller parties matter a lot

Germany’s voting system remains unusually complex and in German federal elections the eventual parliamentary seat count is hard to forecast.  

Unlike voters in most countries, Germans get two votes when electing the Bundestag – one for a local candidate in each of the country's 299 constituencies, and one for a party list. ^[3]Winning 5% of the national vote via the party list is one way to enter the Bundestag under a proportional representation system.  

The other way is to secure so-called "Direktmandate" (best translated as “direct seats”). Voters who are particularly keen to boost a small party’s fortunes therefore have two ways to do so – give it their list vote so that it clears the 5% hurdle nationally or vote for that party’s local candidate, if they happen to live in a district that is unusually favorable to the small party. In most instances, whoever gets the most votes in a district wins a direct seat.^[4] Winning at least three such direct seats (i.e. obtaining a plurality of first votes in at least three constituencies) allows parties to enter the Bundestag and to participate in the distribution of seats allocated via proportional representation defined by the share of second votes.^[5]

Therefore, until the election has taken place, which of the smaller parties will be represented in the lower chamber of Germany’s parliament, the Bundestag, will be unclear. Apart from the Christian Democrats, Social Democrats, Greens and AfD, the only other party that is very likely to win at least one seat is the Südschleswigsche Wählerverband (SSW) – a regional party that many Germans may never have heard of.^[6]

In addition, BSW and The Left, the left-wing parties, have both been hovering at about 5% in polls, with the more right-wing, liberal Free Democrats usually a touch below.

Direct seats may enable smaller parties to enter the Bundestag

The main practical implication of the direct seats is that The Left looks reasonably well placed to get into the Bundestag as it has a decent chance of securing three direct seats in districts in the former communist east -- and a number of well-known incumbents in those seats.^[7]

The right-wing populist Free Voters (FW) are the junior members at present of a ruling coalition in the southern state of Bavaria with the CSU and are targeting four direct seats there, but this is a trickier call.^[8]

By contrast, polling data, electoral history and the campaign so far all suggest that the Free Democrats, whose vote is evenly distributed throughout the country, are unlikely to be in contention for any direct seats, whether or not they fall short of 5% nationally.

1.4 What this means for government formation

How will recent events influence the vote?

The upshot of all this is that investors would be ill-advised to prejudge the likely outcomes of both the election itself and the subsequent process in which a coalition is likely to be formed.

It remains unclear whether the recent votes on immigration in which the Christian Democrats drew on AfD support will help or hurt the party. Merz, the Christian Democrat leader, has made his migration proposals, which will make it harder for immigrants to enter the country, a make-or-break item for coalition negotiations. This could create sizeable obstacles for any coalition with either the Greens or the Social Democrats. And it may be necessary to convince not just the leaders of these parties but also their ordinary members, who are likely to be consulted (one way or the other) on any coalition deal. 

Possible coalition outcomes

Against this backdrop, it is prudent to prepare for a range of election outcomes. In particular, investors should be aware that both a clear result, leading to the rapid formation of a stable coalition with a majority in the Bundestag, and an unclear result, leading to a prolonged period of political uncertainty, are possible.

It may be that the biggest source of uncertainty is the question of which parties secure either at least 5% nationally, or 3 direct seats. The smaller parties represent a combined total of approximately 20% of voters. But if none of them obtains any seats in the Bundestag, a combined voter share of as little as 40% of possible coalition partners would probably be enough to command a majority of Bundestag seats. If, on the other hand, all or most of the smaller parties manage to win some seats, a coalition would probably need to command a combined level of voter support in the 45% to 50% range.

Which of the smaller parties have won seats and what level of popular support is likely to be needed to form a coalition should become clear on election night or soon thereafter. Outperformance or underperformance could lead to significant changes in party leaderships. For example, if the Christian Democrats barely improve on their disastrous 24% of the vote in the 2021 election, the party’s lowest share since WWII, and lose ground to the SPD, the Greens, AfD or even all three, Merz would probably resign, as his predecessor Armin Laschet did in 2021. A departure of Merz, however unlikely it may seem at this stage, might help smooth coalition negotiations, but that would also depend on the profile of whoever succeeds Merz. After voting with AfD, Merz is distrusted by the Greens and the Social Democrats, but most other Christian Democrat Members of Parliament voted likewise. In short, unless there is a dramatic surprise, the next government is likely to be led by the Christian Democrats, but beyond that, a wide range of outcomes is possible.

Could we see a minority government?

Conversely, a surprisingly strong showing for the Christian Democrats, together with a fragmented Bundestag, could paradoxically make cobbling together any governing arrangement that excludes the AfD very hard, as proved the case recently in several East German states, causing minority coalition governments led by the Christian Democrats to be formed in Saxony and Thuringia. It is also worth pointing out that Germany’s so-called Basic Law (the Grundgesetz^[9]) was designed to make it difficult to trigger fresh elections in order to avoid reaching compromises. In theory, at least, Germany looks well prepared to function under a minority government – even if most of the current national political leadership is not.^[10] Bringing down a minority government would be hard, as long as the opposition is divided. Potentially, such a government could try to seek majorities on a case-by-case basis, though we admit that this would very much go against Germany’s political culture. More plausible, at least in theory, would be confidence and supply arrangements of the sort quite common in the states of the former Eastern Germany in the 1990s, when formal coalitions with PDS (predecessor of The Left) were widely considered taboo, but political realities were such that both PDS and Social Democrats had something to gain from the former agreeing not to topple left-leaning state governments in return for policy concessions. This time around, we still find it hard to see any confidence and supply arrangement between Christian Democrats and AfD in the Bundestag, though it could be a topic for after the next election – especially if tried at the state level in the meantime.

1.5 The role of the Bundesrat

Compromises are also encouraged by the fact that power in Germany is widely distributed. Most importantly, the balance of power in the upper house, the Bundesrat, is determined by frequent regional elections in each of the federal states (the Bundesländer) and the subsequent formation of state-level governments. This gives even small parties in government at the state level significant veto power on most matters of legislative significance.

The Bundesrat currently includes all the parties mentioned in this report except the AfD, which so far has no participation in any state government, as all other parties have up until now refused to enter coalitions with it. This means that even if the AfD was somehow able to emerge as the largest force in the next Bundestag and to ally itself with a defeated, shrunken and demoralized Christian Democrat party, the resultant government would be heavily constrained in what it could do, from laws relevant to states to changing parts of the Basic Law.^[11] Whatever the agenda, reforming Germany requires a broad consensus that stretches beyond the parties that are in government nationally.