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LONDON - A momentous German election marking the end of Angela Merkel's 16 years as chancellor is less than a month away and with no clear outcome in sight, markets may start to pay attention.
Germany's centre-left Social Democrats (SPD) have taken a poll lead over Merkel's conservative Christian Democrats (CDU) for the first time in 15 years this week.
Uncertainty has also crept up as the Greens, previously tipped to be the leading party in a coalition with the CDU/CSU bloc, ceded ground in the polls, while approval ratings for CDU leader Armin Laschet have plunged.
For a graphic on German election polls:
The election could yield a "Jamaica" coalition of the CDU/CSU, Greens, and the business-friendly Free Democrats (FDP). Or Europe's largest economy could get a "traffic light" coalition, led by Finance Minister Olaf Scholz's SPD, with the left-leaning Greens and the FDP as junior partners.
The terms reflect the symbolic colours of the parties - black for CDU/CSU, yellow for FDP, green for the Greens and red for SPD.
German elections rarely make market waves but the range of possible outcomes is wider than in the past, said Berenberg chief economist Holger Schmieding, who sees the shift towards the SPD as "modestly negative for markets" because it raises the risk of protracted uncertainty.
"For the first time this year, polls suggest that a two-way coalition between the CDU/CSU and the Greens would be narrowly short of a majority of seat," Schmieding said.
For a graphic on German coalition odds after the Sept. 26 election:
Here are some potential market implications:
1) AUSTERITY IS HISTORY?
The pandemic forced Germany to reverse long-observed fiscal restraint and focus initially had been on whether the Greens could make that change permanent as they had led the polls. The party pledges spending increases and reform to a debt brake which limits new federal borrowing to just 0.35% of GDP.
"In general, across all parties, maybe with the exception of the Liberals, there is a tendency to give the government a little bit more (fiscal) leeway," said Joern Wasmund, global head of fixed income at DWS.
Structurally higher spending and borrowing would lift bond yields, and by potentially improving economic growth prospects, also the euro. But the CDU or the FDP, which will almost certainly join any coalition, want to reinstate the debt brake.
"My bet is there is a chance of 70% that the CDU-CSU will be part of the next German coalition, which means we won't see a major change in terms of fiscal spending," said Christopher Dembik, head of macro analysis at Saxo Bank.