Today we have the crucial German elections. Current polls point to a two-way coalition led by the Conservatives. A CDU/CSU-SPD "grand coalition" would be a well-known option (3 grand coalitions in past 20 years), while a CDU/CSUGreen coalition would be a novelty at the federal level. We expect the new government to quickly embark on finding a cross-party consensus on topping up the EUR 100 bn off budget defence fund or introducing a golden rule for defence. US pressure to increase defence spending/securing the Ukraine peace deal to act as an additional catalyst. We believe it is plausible to assume a net fiscal easing of around 0.5% of GDP by 2026. Much of this is likely to come from greater defence spending, where the short-term growth impact may be limited. Beyond defence, we see an easing of the debt brake at the state level as likely and potentially meaningful, as it could unlock substantial public investment and consumption with high multipliers. With chances of a large defence spending increasing along with fiscal purse loosening in German economy, DAX (German stock index) has outperformed S&P500 recently. Even the 10yr German bond yield spread with 10yr UST has narrowed recently. A large defence spending along with higher German govt spending on federal level does not augur well for future inflation. Hence while growth might pick up, inflation too might start consolidating at higher levels. This implies lower probability for ECB to cut rates to below neutral level by end CY25. We expect neutral at 1.75-2% for ECB. Current deposit rate is 2.75. So, we reduce the number of cuts to maximum 3 in REMCY25 for ECB and hence now reverse our call on EUR. EUR now becomes a buy on dips and the parity view is not feasible any more considering the new political discourse in Eurozone with US asking EU to spend more on defence. We now see EUR at 1.08 by end CY25.
