Executive summary:
- The conservative Christian Democrats (CDU/CSU), led by Friedrich Merz, won Germany's 23rd February elections but garnered only 28.5% of the vote. Because of this, Merz—who will become the next chancellor of Germany—will need to form a coalition government with at least one other party.
- The outgoing Social Democrats (SPD), headed by current Chancellor Olaf Scholz, captured just 16.4% of the vote—their worst performance since World War II. The party was topped in the polls by the far-right Alternative for Germany (AfD), which came in second with an unprecedented 20.8% of the vote.
- Although the Social Democrats suffered heavy losses, they are still likely to be the junior partner in the next coalition government led by Merz and the CDU/CSU, as Merz has ruled out working with the AfD.
- Financial markets rose on the likelihood of a two-party coalition between the CDU/CSU and the SPD, with Germany's benchmark DAX Index up 0.7%.
Europe’s largest economy has voted for a new government. The right-of-center Christian Democrats (CDU/CSU) will lead it, and their leader Friedrich Merz is set to be the next chancellor of Germany. However, with the CDU/CSU securing only 28.52%1 of the vote, they will need at least one coalition partner to form a government.
German election vote share
Source: Federal Elections Returning Officer, as of 24 February 2025, 6:44 CET
All traditional parties have ruled out working with the far-right Alternative for Germany (AfD) who won an unprecedented 20.8% of the vote and emerged as the second-largest party. The AfD gained 10.4 percentage points compared to the 2021 election. The surge in far-right support in the German electorate, along with gains for the far-left party Die Linke on 8.77%, leaves the Bundestag as fragmented as ever.
The parties of the outgoing government were punished for their track record. Chancellor Olaf Scholz's Social Democrats (SPD) suffered a dramatic decline, recording their worst post-war performance at 16.41%. The Greens limited their losses and garnered 11.61%. In a sign that the electorate held them responsible for the government’s collapse, the Liberal Democrats (FDP) failed to clear the 5% hurdle and will not sit in the next Bundestag. Nor will the far-left BSW (4.97%), a breakaway party from Die Linke.
Germany’s economy falling behind despite low unemployment
The reasons for the increasing fragmentation of the political landscape are manifold. They reflect a deeper economic paradox: near-record low unemployment yet record-high concern about the economy. Polling from Forschungsgruppe Wahlen (see Chart) shows a growing belief that the country is on the wrong track.
Concerns for German voters
Source: Forschungsgruppe Wahlen, 14 February 2025
Despite full employment, Germany has been in mild recession for two consecutive years, with GDP shrinking 0.2% in 2024 and 0.3% in 2023. Stagnant growth, high energy costs, and rising global competition have fueled economic pessimism among the populace. Once a world leader in engineering, Germany is now seen as falling behind in key technologies like semiconductors, artificial intelligence, software, and - most painfully - automotive engineering. Its car industry, long an economic pillar, is struggling against fierce competition from China in the electric vehicle market.
Immigration concerns underpin AfD’s surge
After the invasion of Ukraine by Russia in 2022, energy prices surged in Europe, straining German consumers and industries. Energy security and climate policy were major concerns for the electorate in recent years but have now been overtaken by immigration and the integration of foreigners, explaining the AfD’s surge.
Difficult trade-offs await Mr Merz. With an ageing population, Germany needs skilled foreign workers but the attitude towards immigrants has been negatively affected by violent extremist attacks carried out by asylum seekers. The new government needs to balance the worries of a significant share of the population about immigration and integration with the need for Germany to remain open to the skilled foreign workers the country needs, and to those fleeing war and persecution.
Markets focus on coalition negotiations…
Financial markets breathed a sigh of relief when it became clear that the CDU/CSU could form a government with the SPD. The euro rose by 0.5% vis-à-vis the US dollar to 1.05 and DAX futures also recorded gains of 0.9% as of 7:30 GMT this morning.
Merz (and the markets) prefer a two-party coalition to a three-party coalition that would include the Greens. The former will be easier to negotiate and more likely to last the full term. Since the FDP and far-left BSW did not clear the 5% hurdle, an alliance between the CDU/CSU and SPD will have a slim majority in the Bundestag. Once called the “grand coalition”, support for both parties has shrunk over the years. They now need to work together again, having governed Germany four times since the founding of the Federal Republic. The presumptive chancellor has given himself until Easter to conclude coalition talks, a tight timeline by German standards.
…and the debt brake
Markets will closely watch the new government’s stance on the “debt brake policy”, which restricts federal budget deficits and has limited the government's ability to loosen fiscal policy. While consensus exists to uphold this policy, fierce debate surrounds its flexible interpretation, particularly regarding defense spending amid rising geopolitical tensions.
Germany also needs more investment in transport infrastructure, energy security, and education. Markets are watching whether a new government can reform the debt brake to allow for such investments. However, the parties of the center do not hold the two-thirds seat majority needed for constitutional reform so they would need either the AfD or Die Linke to go along.
The bottom line
Germany has voted. A high turnout of 82.5% showed how much was at stake at this election. The conservative CDU/CSU is set to lead the new government by becoming the strongest party in the Bundestag, albeit with a vote share of only 28.52%. The center of German politics just about held, with the Social Democratic SPD suffering heavy losses, but still likely to be the junior partner in the next coalition government led by Friedrich Merz of the CDU/CSU.
Financial markets were relieved that the AfD’s vote share was limited to 20.8% and that a two-party coalition between the CDU/CSU and SPD remains feasible. Germany’s traditional governing parties, from which every chancellor since 1949 has come, must now demonstrate they can address the country’s pressing challenges. If they fail, shutting out the AfD from power may prove impossible next time.
1 According to preliminary results by the Federal Elections Returning Officer (Bundeswahlleiterin).
Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.