UBS Outlines Germany’s Political Scenarios as Election Risks Rise

Germany’s political outlook has become more uncertain after a series of regional election setbacks for Chancellor Friedrich Merz’s governing coalition, prompting investors to reassess the risks surrounding economic reforms, fiscal policy and Germany’s growth outlook.

UBS had identified several possible political scenarios even before the latest regional votes, including changes in government leadership, adjustments to the coalition’s reform programme and, in a more disruptive scenario, a confidence vote that could lead to an early federal election. The bank also stressed that Germany’s constitutional framework makes removing a chancellor without an agreed replacement difficult.

The latest elections have made those questions more relevant, although there is no evidence that an immediate change of federal government is underway. Merz has said he intends to remain chancellor and continue his reform programme.

For investors, the important issue is not simply which party gains support. It is whether political fragmentation affects Germany’s ability to implement its large fiscal spending programme and structural reforms.

Why Germany’s Political Risk Has Increased

The pressure intensified after regional elections in September.

In Saxony-Anhalt, the Alternative for Germany (AfD) won 43.8% of the vote and 39 of the state parliament’s 83 seats, falling short of an outright majority. UBS noted that the direct federal-policy impact of the result was limited because Saxony-Anhalt holds only four of the 69 seats in Germany’s Bundesrat, the upper house.

The political significance was nevertheless broader. UBS said the AfD was also leading national polling at the time and that the CDU/CSU-SPD coalition no longer held a national majority in polling.

The situation became more complicated after the September 20 elections in Mecklenburg-Western Pomerania and Berlin. In Mecklenburg-Western Pomerania, Reuters reported that the AfD took first place with about 38.3% in projections, while Merz’s CDU fell below the 5% threshold required to enter the state parliament. In Berlin, the CDU also lost ground while the Left Party emerged as the largest party.

Merz described the Mecklenburg-Western Pomerania result as a “disaster” but said he would continue as chancellor and pursue his reform agenda.

UBS Identifies Several Possible Federal Scenarios

UBS’s analysis focuses on the distinction between political pressure and an actual change in Germany’s federal government.

One constitutional route would be a constructive vote of no confidence under Article 67. Under this mechanism, the Bundestag does not simply remove a chancellor; it must simultaneously elect a replacement. UBS said this would require the CDU/CSU and SPD to agree on another candidate.

A second route would involve Merz himself calling a vote of confidence. If he lost that vote, it could create a path toward new federal elections, subject to Germany’s constitutional procedures.

UBS nevertheless said most political observers it consulted regarded these scenarios as unlikely at that stage. The bank expected political attention to remain focused on regional elections and the government's legislative agenda rather than an immediate federal election.

The latest regional results have increased pressure on the coalition, but Merz's decision to remain in office means the focus has shifted toward whether the CDU/SPD government can maintain enough parliamentary support to pass its planned measures. Reuters reported on September 23 that the coalition partners still intended to continue working together, while internal pressure was growing for changes to the government's policies.

The Bigger Economic Question: Can Germany Keep Reforming?

Politics matters to markets mainly when it changes economic policy.

Merz’s government has been pursuing reforms involving taxes, pensions and healthcare while simultaneously implementing a large fiscal spending programme designed to support infrastructure and defence.

UBS had forecast German GDP growth of 1% in 2026 and 1.5% in 2027, with fiscal stimulus contributing around 60 basis points to growth in each year.

That outlook creates an important link between political stability and economic performance.

If the government maintains enough political support, fiscal spending can continue while structural reforms move through parliament. If coalition disagreements become stronger, however, some reforms could be delayed or diluted.

Reuters reported that SPD members have already pushed for changes to parts of Merz’s pension and healthcare agenda following the regional election results. The debate includes proposals affecting early retirement and other social-policy measures.

This does not necessarily mean Germany’s fiscal expansion will stop. UBS said the expansion would face a more serious threat only if the government broke down and could no longer pass the annual budgets needed to implement it.

Three Economic Risks UBS Highlighted

UBS identified several ways the political environment could affect its economic forecast.

The first is greater fiscal support. The government could respond to electoral pressure by concentrating more heavily on measures intended to improve growth and public sentiment. That could provide additional near-term economic support.

The second is slower structural reform. If the government interprets the AfD’s gains as evidence that voters are resisting parts of its reform agenda, it could scale back some measures. UBS said the direct economic effect of such a change would probably be moderate, but it could affect investor sentiment toward Germany.

The third and more consequential scenario is government breakdown. A loss of confidence followed by political instability could interfere with the passage of annual budgets and therefore affect the implementation of Germany’s fiscal expansion.

These are scenarios rather than predictions. The eventual outcome depends on parliamentary arithmetic, coalition negotiations and decisions by Germany’s political parties.

Why Investors Are Watching Germany Closely

Germany remains the largest economy in Europe, so changes in its fiscal and economic policy can affect the wider euro area.

German government bonds are particularly important because Bund yields influence borrowing costs across European markets. Political uncertainty can also affect expectations for government spending, deficits, economic growth and the euro.

Equity investors have another consideration: Germany’s industrial sector is highly exposed to the domestic economy, European demand, energy costs and global trade.

A prolonged period of weak growth combined with political uncertainty could make corporate investment decisions more difficult. Conversely, continued fiscal spending on infrastructure and defence could support demand in sectors linked to construction, engineering, industrial equipment and defence.

The impact will therefore vary significantly by company and sector rather than affecting the entire German market in the same way.

The AfD Factor and the 2029 Federal Election

The AfD’s performance has become an important part of Germany’s political landscape.

In the 2025 federal election, the party received 20.8% of the second vote and won 152 Bundestag seats, making it the second-largest party by seats behind the CDU/CSU grouping.

Its subsequent regional gains have increased pressure on Germany’s established parties. Reuters reported that the CDU’s traditional strategy of excluding the AfD from governing coalitions has so far kept it out of state and federal government, but the party’s expanding electoral support is creating questions about how that strategy will function in future elections.

That does not determine the outcome of the next federal election, which is currently scheduled for 2029. It does, however, mean that political developments before then could influence the policy debate around immigration, energy, defence, taxation and Germany’s relationship with the European Union.

What Investors Should Watch Next

The most important indicators are now economic as much as political:

• 2027 budget negotiations: Whether the government maintains its planned fiscal expansion.

• Pension and healthcare reforms: Whether coalition disagreements lead to substantial changes.

• Coalition stability: Whether CDU/CSU and SPD continue to support the government’s programme.

• Regional elections in 2027: Particularly votes in larger western German states.

• German bond yields: A key market indicator of fiscal and political risk.

• Business investment: Whether fiscal spending translates into stronger private-sector activity.

• Economic growth: Whether Germany’s recovery strengthens enough to reduce political pressure.

The distinction between political headlines and actual policy changes will be important. A change in polling or a regional election result does not automatically alter federal fiscal policy.

Conclusion

Germany is entering a period in which political fragmentation and economic reform are increasingly connected. UBS has outlined constitutional and policy scenarios ranging from continued government stability with modified reforms to more disruptive possibilities involving a confidence vote and potentially new federal elections.

The latest regional election results have increased pressure on Merz and his coalition, but the chancellor has committed to staying in office and continuing his reform programme.

For investors, the key issue is whether Germany can maintain its planned fiscal expansion while delivering structural reforms despite rising political pressure. German bond yields, the 2027 budget, coalition negotiations and upcoming regional elections will provide important signals about the direction of policy.

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This article is for informational and educational purposes only and should not be considered investment advice.