German elections: Fragmented parliament to complicate government formation and reforms

Highlights:

• German federal elections on Sunday resulted in a narrow lead of the Social Democrat SPD over a plummeting CDU/CSU of the outgoing chancellor Merkel. Yet both top candidates, finance minister Olaf Scholz of the SPD and Armin Laschet of the CDU/CSU, have claimed a mandate to lead a new government.
• With a renewal of the ‘grand coalition’ off the table for now, any new government would include the soaring Greens and the steady liberal FDP. The poor faring of the Left erased the option of a left-wing coalition with the SPD and the Greens.
• Government formation in the fragmented new parliament is set to prove difficult and will likely drag at least until year-end. The most likely outcome may be a ‘traffic light’ coalition headed by SPD candidate Scholz with the Greens and FDP – but it is a tight call. Divergent positions in many policy fields (including on taxes and debt) may neutralize most of the bolder reform ambitions promoted by each of the parties.
• With the question of government formation still wide open, the instant market response has been muted, with EUR and yields little changed. Yet the voters’ exclusion of the far Left from any new government and losses amid the eurosceptic AfD may have added to this morning’s equity gains and the outperforming German DAX.
   

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