Germany's AfD, Left win enough seats to veto constitutional changes

By Maria Martinez and Christian Kraemer

The far-right Alternative for Germany (AfD) and the Left Party jointly secured one third of seats in the new parliament, enough to block a loosening of Germany's debt brake - a mechanism some investors and political parties say stymies economic growth.

The euro and German stocks rallied on Monday as investors welcomed the strong likelihood of a conservative-led coalition, though their optimism was tempered by the prospect of potentially tricky negotiations ahead over economic policy.

German business leaders called on Berlin to form a new government swiftly, saying that Europe's largest economy could not afford to waste any time as companies suffer from high costs, red tape and rising competition from abroad.

Markets are now focused on the chances of reforming or scrapping the debt brake. This mechanism limits budget deficits to 0.35% of gross domestic product, though that excludes top-ups of the special fund for defence or creation of any new fund.

However, both the AfD and the Left oppose military aid to Ukraine, and with their new-found strength in the Bundestag lower house they could veto increased defence contributions, creating tensions with Germany's NATO allies, including the Trump administration which wants Europe to spend much more.

Germany's outgoing parliament still has the majority needed to reform the debt brake before a new coalition is formed but such a move by the current assembly is "unrealistic", Finance Minister Joerg Kukies told Reuters in an interview on Monday.

"First of all, there's far too little time, and secondly, it would also be a questionable political signal if constitutional amendments were now made with an old majority," Kukies said.

German conservatives under likely next chancellor Friedrich Merz have vowed to move quickly to try to form a coalition after winning the most votes in Sunday's national election.

The most likely outcome is a coalition of Merz's conservative bloc and the Social Democrats (SPD), who came in third, after the AfD surged to a historic second place.

Germany's Ifo economic institute stressed the urgency of forming a new government.

"The German economy is in waiting," said its president Clemens Fuest, after Ifo's business climate index came in at 85.2 for February, flat on the previous month.

INFURIATING TRUMP?

Holger Schmieding, chief economist at Berenberg, said the new coalition may struggle to find the fiscal space to raise spending on defence while also easing the tax burden for workers and firms.

"A failure to ramp up military spending could get Germany into deep trouble with its NATO partners," Schmieding said. "By infuriating U.S. President Donald Trump, it could also add to the risk of a U.S.-EU trade war."

The Left would be open to loosening the debt brake but not to allow greater defence spending, economists say.

"The Left would like to ditch the debt brake. However, its agenda - soak the rich, spend more on welfare and less on defence- is the very opposite of the Merz agenda," said Carsten Brzeski, global head of macro at ING.

In order to increase defence spending from the current 2% of GDP to 4%, for example, the federal government would have to cut non-defence spending by a quarter if this were not to be financed by additional debt, said Joerg Kraemer, chief economist at Commerzbank.

A new Merz-led government might win the backing of the Left Party for topping up the special defence fund if in return it set up a new fund for higher infrastructure spending or agreed to generally relax the debt brake by excluding infrastructure investments from the debt rule, Kraemer said.

If this did not succeed, Kraemer said the only other politically feasible option would probably be to suspend the debt brake by invoking an "extraordinary emergency situation", which is possible with a simple parliamentary majority.