Macroeconomy

As coalition talks begin, what next for the German Bund?

Our central scenario is that there will be a limited shift in German fiscal policy in the aftermath of the federal elections and that 10-year Bund yields will stabilise around current levels.

Nadia Gharbi & Lauréline Renaud-Chatelain , Pictet Wealth Management

As coalition talks begin, what next for the German Bund?

The results of the federal election in Germany on 26 September were very tight, with the Social Democratic Party (SPD) slightly ahead of the CDU/CSU. As a result, the Greens and the Free Democratic Party (FDP) are in effect the ‘kingmakers’. Among the various coalition possibilities, our base case is still for a ‘Traffic Light’ coalition (SPD, Greens and FDP) led by the SPD, with the party’s Olaf Scholz as Chancellor. But it’s a close call.

At this stage, there is not much visibility about the future direction of policy in Germany. Decarbonisation of the economy will probably rank high on the incoming government’s agenda, but this ambition will come at a cost. The Greens are likely to insist on public investment to meet Germany’s net zero emissions target, whereas the FDP wants to reduce the tax burden and is opposed to any reform of the debt brake. The gap between the two parties will need to be bridged.

With a first ECB rate hike being priced in for the end of 2023 and limited risk of a major shift in Germany’s fiscal policies in the aftermath of the election, our central scenario is for the 10-year German Bund yield to stabilise around -0.25% by the end of the year (compared with -0.22% on 27 September).

Although inflation expectations have already risen significantly, we cannot rule out that they will rise more. In an alternative scenario where euro area price pressures prove persistent, market participants might expect inflation to average more than 2% over the next ten years, pushing the 10-year Bund yield up more.

An increase in infrastructure spending at both the German and EU levels could boost GDP growth potential over the medium term. As such, we will closely monitor the coalition talks, the spending proposals that a new coalition comes up with and tweaks to the EU’s Stability and Growth Pact. If higher investment boosts potential euro area economic growth, the ECB might hike more quickly than we currently expect, and by more. However, in our view the likeliest outcome is that policy rates will remain lower for some time, and that the rate-hiking cycle in the euro area will be shallower and start later than in the US or UK.

Download full article

Subscribe
Our views on the economy, markets and trends as a weekly digest, straight to your inbox.

We've sent you an e-mail.
Follow the instructions to confirm your subscription.

I didn't receive an e-mail