The German election is over, but the wait for the final result continues. The centrist-left SPD party under the leadership of Olaf Scholz won 25.7% of the vote, only a slim margin over the centrist-right CDU (Angela Merkel’s party), which won 24.1% of the vote.1 Given the very narrow spread and the fact that two other parties – the Greens and the liberal FDP – together won over a quarter of the total vote, both the liberal SPD and conservative CDU are aiming to form a coalition government with representation from all four parties.
What does this mean for markets? There is hope that the government will be formed by Christmas. While we wait, this week’s commentary explores the direction of Germany and Europe broadly in the wake of this pivotal election.
An (eventual) adherence to debt rules expected, with added flexibility to focus on investments
The pandemic allowed Europe to relax budget rules temporarily – with typical limits of 60% debt-to-GDP and budget deficits of no more than 3% suspended until 2023. Thirteen out of 27 EU countries are well above the debt threshold, and all but Denmark and Sweden run deficits well in excess of 3%.2 Importantly, discussions will kick off in the coming weeks (and should last well into next year) about how the budget rules will be amended for 2023 and beyond. Germany’s new coalition government will play a key role in those negotiations.
In our view, the new German government is unlikely to veer far from its historical preference for strong debt controls. A CDU-Greens-FDP alliance would signal continuity of fiscal conservatism and support for debt rules. But even if the new government results from a left-leaning SPD-Greens-FDP alliance, with SPD and Greens supporting more spending flexibility and a stronger EU fiscal union, the FDP influence would likely keep SPD and Greens ambitions in check, helped by public opinion and Germany’s constitutional debt brake.
A quick return to fiscal austerity under either coalition government seems unlikely, however. The EU unemployment rate remains at 7.6% versus 5.2% in the United States; core inflation has risen only to 1.6% – the highest level since 2012, while in the United States, it is at 3.6%, the highest since the early 1990s; and the pandemic remains a significant threat.
Rather than austerity, it is likely that a new German government will support additional flexibility in the timing of a return to debt rules enforcement for EU countries and, potentially, offer some exceptions from enforcement. In late 2020, the European Council passed a long-term recovery budget of EUR 1.2 trillion that will run from 2021 to 2027, with each member state’s contribution determined by its economic size and strength. Germany will be the largest contributor. Given this commitment, reining in Germany’s or other member states’ budget deficits will require either sharp domestic spending cuts or more flexibility during the next seven years. We think the latter is more likely.
All parties want progress on climate; some more quickly than others
The fiscal flexibility may also be more tolerable because 30% of the long-term budget will be spent fighting climate change – the highest share ever, from the largest EU budget ever.3 Climate emerged as a clear priority in the German elections. The Greens received 14% of the vote, much more than the 8.9% won in 2017.4 Additionally, a top German court ruled earlier this year that climate laws must be updated by the end of 2022 to chart a path to net-zero emissions by 2050.
With a focus on climate change in any future coalition government assured, the question turns to how much will be done and how quickly. The SPD and CDU may aim for net zero by 2045, while the Greens may push for it by 2040. For the EU more broadly, the European Green Deal requires reducing greenhouse gas emissions by at least 55% by 2030 and adopts a 40% new renewable energy target for 2030 and zero emissions from new cars by 2035.5
Investing in climate and digital infrastructure in Europe
In addition to directing 30% of the EU long-term budget to climate investments, 20% of the EUR 723.8 billion Recovery and Resilience Facility (also passed to mitigate pandemic impacts) will be invested in the EU’s digital transformation, including in supercomputing, artificial intelligence, cybersecurity, and other advanced digital initiatives.
This strong government support for climate and digital infrastructure should also incentivize investor flows into these technologies. For example, the EMEA region invested $177 billion in de-carbonization technologies in 2020, far surpassing previous totals.6 This investment should continue to rise as EU-27 is still approximately 14.5% behind schedule in reaching its 2030 renewable energy consumption target.
On the digital infrastructure side, growth in data center investment in Europe is forecast to outpace that of the United States, and large-scale investments in fiber assets will bring faster connectivity to homes, businesses, and data centers. Private capital is positioning accordingly – by raising funds and investing in companies supporting this climate and digital infrastructure transition. 2021 has been a record year for venture capital in Europe, for example, with 58 unicorn deals in the first half of 2021 – only 36 were completed during all of 2020. 7
To us, it’s the certainty around commitment to these investments that stands out, even amid the still-murky future of Germany’s coalition government.
(1) Source: BBC, “Germany elections: Centre-left claim narrow win over Merkel's party,” September 27, 2021. https://www.bbc.com/news/world-europe-58698806
(2) Source: Eurostat, April 4, 2021.
(3) Source: European Commission, “The EU’s 2021-2027 long-term budget and Next Generation EU Facts and Figures”
(4) Source: AP News, “The Latest: Social Democrats beat Merkel bloc in German vote,” September 27, 2021. https://apnews.com/article/germany-election-live-updates-8dee19485e83b9c7aa8859d81c2fbb29
(5) Source: European Commission, “Delivering the European Green Deal.” https://ec.europa.eu/info/strategy/priorities-2019-2024/european-green-deal/delivering-european-green-deal_en
(6) Source: BNEF, Energy Transition Investment Trends 2021.
(7) Source: Pitchbook, European VC Valuations Report, Q2 2021.
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