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Germany towards a coalition between Cdu and Spd: challenges on defence and economic reforms

The new German government will face challenges in reforming the debt brake and investing in defence and reducing energy costs, while economic instability requires long-term solutions

After the elections in Germany on Sunday, a coalition between the CDU and the Social Democrats (SPD) seems the most likely scenario. However, this alliance would not achieve the two-thirds majority needed to make changes to the constitution, complicating plans to reform the debt brake, one of the key objectives of the election campaign. In addition to addressing this issue, the new executive will focus on increasing defence spending and investment, as well as trying to reduce energy costs, which have risen sharply since the Russian invasion of Ukraine.

César Pérez Ruiz, Head of Investments & CIO at Pictet Wealth Management, noted that the Cdu-Csu victory is positive for the markets, allowing for a modest fiscal expansion, while pointing out the risks due to the presence of a blocking minority from smaller parties. Martin Skanberg, Fund Manager at Schroders, also highlighted the need for reforms to increase Germany’s competitiveness, while acknowledging that the details will take time to work out.

From an economic perspective, the implications of the elections will not be apparent until 2026, said Irene Lauro, European Economist at Schroders. Merz has declared a willingness to review the debt brake, but the presence of the AfD and Die Linke as a minority makes this review complex. Furthermore, President Donald Trump has urged Europe to increase defence spending, with Germany currently allocating only 1.4 per cent of GDP. Merz’s goal would be to raise military spending to 3.5 per cent, which is necessary to guarantee independence from US protection.

Besides defence, another priority of the new government will be to reduce energy costs, which have risen sharply following the war in Ukraine. A reduction in energy taxes and investments in renewable infrastructure are assumed. Other proposals include reducing corporate and income taxes, which could benefit businesses and consumers, but the financial coverage of such policies remains uncertain.

The German economic environment, marked by a 0.2 per cent contraction in the fourth quarter of 2024, contributed to voter distrust, complicating the mandate for the Cdu-Spd coalition. Richard Flax, Chief Investment Officer at Moneyfarm, pointed out that Germany’s economic stagnation makes it more difficult to get a clear mandate, while Trump’s handling of relations with the US and the possibility of trade sanctions remain critical challenges for the future executive.

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