BERLIN — Initial projections of the result of Germany’s election on Sunday set the stage for protracted coalition talks, meaning Europe’s largest economy could face months of policy uncertainty prolonging its current stagnation.

The opposition conservatives won the election, putting leader Friedrich Merz on track to be the next chancellor. The far-right Alternative for Germany (AfD) came in second, its best ever result, exit polls showed.

It was far from clear, however, whether Mr. Merz would need a further one or two parties to form a coalition with a working majority in a fragmented parliament.

Coalition talks will be complicated and prone to setbacks, leaving consumer and business confidence subdued, said Carsten Brzeski, global head of macro at ING, adding it remained to be seen what policies the coalition partners could agree on.

“As long as the new government does not bring significant change, foreign investments will also be held back, weakening Germany’s economic outlook,” Mr. Brzeski said.

ECONOMIC LAGGARD
Germany has gone from being Europe’s economic powerhouse to becoming the euro zone’s growth laggard. How to revive the economy was has been one of the main election campaign topics.

It is still unclear how many parties will clear the 5% threshold needed to secure seats in parliament.

If the leftist BSW and the Free Democrats (FDP) stay below that threshold, a two-party coalition of Mr. Merz’s CDU/CSU and SPD would be possible. But if they both make it into parliament, it would have to be a three-party coalition with the ecologist Greens or the FDP, a staunch backer of fiscal austerity.

“A three-party coalition runs the risk of more muddling through and more stagnation unless all parties involved realize that this is the last chance to bring change and to prevent the AfD from getting stronger,” Mr. Brzeski said.

A three-way coalition could still implement some of the income and business tax cuts proposed by the CDU, but agreeing budgets and major structural reforms would be harder, said Franziska Palmas, senior Europe economist at Capital Economics.

The CDU and the Free Democrats propose reducing Germany’s combined corporate tax rate from approximately 30% to below 25%, bringing it closer to the OECD average of 23.85%.

“Cutting the combined corporate income tax rate would be a good first step toward making Germany’s corporate tax system more competitive,” said Alex Mengden from Tax Foundation Europe.

This change would boost Germany’s investment by 1.4%, Gross Domestic Product by 1%, and wages by 0.8%, according to estimates of Tax Foundation Europe.

Other parties have criticized the CDU, arguing that the party does not spell out how all its promised tax cuts would be financed. The full CDU reform program would reduce state revenue by 97 billion euros ($102 billion) per year, according to an Ifo study.

Holger Schmieding, chief economist at Berenberg, said he expected Germany to get some pro-growth reforms but added:

“Whether it will be a small or a major package depends on two things: the negotiating skills of chancellor-to-be Friedrich Merz and, more importantly, whether the debt brake can be reformed.”

If the FDP makes it into parliament, a reform of Germany’s constitutional debt brake, which limits the federal government’s budget deficit to a mere 0.35% of output, would be difficult.

“If the FDP is needed for debt-brake reform or for a coalition, the changes to the fiscal straitjacket would be more modest,” said Mr. Schmieding, adding that the emphasis in that case would likely be more on pro-growth supply-side reforms.

Ms. Palmas said debt brake reform looked in the balance because the main parties which could have supported it — the CDU, SPD and Greens — still might fall short of the two-third majority needed to approve it.

“I still wouldn’t completely rule it out because it will be extremely difficult for the next government to produce budgets that comply with the current very strict rule, especially, if defense spending needs to be raised,” Ms. Palmas said. — Reuters

VATICAN CITY — Pope Francis, in critical condition battling double pneumonia, had a “good” night in hospital, slept and is resting, the Vatican said on Monday.

The 88-year-old pope was admitted to Rome’s Gemelli hospital on Feb. 14 after having trouble breathing for several days, and subsequently had pneumonia diagnosed in both lungs.

The Vatican described his condition as critical for a second day on Sunday and that he had an “initial, slight insufficiency” in his kidney function that day.

The prognosis for the pope, who required a transfusion of two units of blood on Saturday after experiencing a “prolonged asthma-like respiratory crisis,” remains “guarded,” according to the latest medical update.

“It was a good night, the pope slept and is resting,” the Vatican said in a one-sentence update on Monday morning that did not provide further information.

Double pneumonia is a serious infection that can inflame and scar both lungs, making it difficult to breathe. The Vatican has described the pope’s infection as “complex,” and that it was caused by two or more microorganisms.

Francis, who has been pope since 2013, has suffered bouts of ill health over the past two years. He is particularly prone to lung infections because he developed pleurisy as a young adult and had part of one lung removed. 

PILGRIMS PRAY FOR POPE
Near the Vatican, pilgrims expressed concern for the pope.

“I am very, very sad,” said Elvira Romana, from Italy. “I don’t know how you can continue normally at this moment.”

Matteo Licari, from Sardinia, said he was “extremely worried.” “Let’s hope he can keep living,” said Mr. Licari. “We are waiting for him to come back here.”

Outside Gemelli hospital, people gathered to pray near a statue of the late Pope John Paul II, who was treated at the facility many times during his long papacy.

People left flowers and notes for Pope Francis, and lit candles at the base of the late pope’s memorial.

In a written message for his usual Sunday prayer in St. Peter’s Square, which the pope was unable to read out for a second consecutive week, Francis said he was continuing “confidently” with his treatment in hospital. He thanked his doctors and people who have sent him messages of support.

Archbishop Rino Fisichella, a senior Vatican official, told participants at a Mass in St. Peter’s Basilica on Sunday morning they should make their prayers for Francis “stronger and more intense.”

The Diocese of Rome, which the pope leads, held a special Mass on Sunday evening to pray for Francis, so that he will have “the strength necessary to get through this moment of trial.” — Reuters

LONDON — Russia’s overheating economy is on the cusp of serious cooling, as huge fiscal stimulus, soaring interest rates, stubbornly high inflation and Western sanctions take their toll, but after three years of war, Washington may just have thrown Moscow a lifeline.

US President Donald Trump is pushing for a quick deal to end the war in Ukraine, alarming Washington’s European allies by leaving them and Ukraine out of initial talks with Russia and blaming Ukraine for Russia’s 2022 invasion, political gifts for Moscow that could also bring strong economic benefits.

Washington’s push comes as Moscow faces two undesirable options, according to Oleg Vyugin, former deputy chairman of Russia’s central bank.

Russia can either stop inflating military spending as it presses to gain territory in Ukraine, he said, or maintain it and pay the price with years of slow growth, high inflation and falling living standards, all of which carry political risks.

Though government spending usually stimulates growth, non-regenerative spending on missiles at the expense of civilian sectors has caused overheating to the extent that interest rates at 21% are slowing corporate investment and inflation cannot be tamed.

“For economic reasons, Russia is interested in negotiating a diplomatic end to the conflict,” Mr. Vyugin said. “(This) will avoid further increasing the redistribution of limited resources for unproductive purposes. It’s the only way to avoid stagflation.”

While Russia is unlikely to swiftly reduce defense spending, which accounts for about a third of all budget expenditure, the prospect of a deal should ease other economic pressures, could bring sanctions relief and eventually the return of Western firms.

“The Russians will be reluctant to stop spending on arms production overnight, afraid of causing a recession, and because they need to restore the army,” said Alexander Kolyandr, researcher at the Center for European Policy Analysis.

“But by letting some soldiers go, that would take a bit of pressure off the labor market.”

War-related recruitment and emigration have caused widespread labor shortages, pushing Russian unemployment to a record low 2.3%.

Inflation pressure could also ease, Mr. Kolyandr added, as peace prospects may make Washington less likely to enforce secondary sanctions on companies from countries like China, making imports more straightforward and, therefore, cheaper.

NATURAL SLOWDOWN
Russian markets have already seen a boost. The rouble surged to a near six-month high against the dollar on Friday, buoyed by prospects for sanctions relief.

Russia’s economy has grown strongly since a small contraction in 2022, but authorities expect 2024’s 4.1% growth to slow to around 1-2% this year and the central bank is not yet seeing sustainable grounds to cut rates.

When holding rates at 21% on Feb. 14, Central Bank Governor Elvira Nabiullina said demand growth has long been faster than production capacity, hence the natural slowdown in growth.

The bank’s challenge in finding a balance between growing the economy and lowering inflation is complicated by rampant fiscal stimulus. Russia’s fiscal deficit ballooned to 1.7 trillion rubles ($19.21 billion) in January alone, a 14-fold increase year on year as Moscow frontloads 2025 spending.

“…it is very important for us that the budget deficit…remains as the government is currently planning,” Ms. Nabiullina said.

The finance ministry, which expects a 1.2-trillion ruble deficit for 2025 as a whole, rejigged its budget plans three times last year.

CARROT & STICK
The war has brought economic advantages for some Russians but pain for others.

For workers in sectors linked to the military, fiscal stimulus has sharply raised wages, while others in civilian sectors struggle with soaring prices for basic goods.

Some businesses have seized opportunities presented by huge shifts in trade flows and reduced competition. For example, Melon Fashion Group’s revenues have steadily risen as it has ridden the consumer demand wave. 

Melon’s brands have significantly expanded over the last two years, the company told Reuters, and since 2023, the average size of stores it opens has doubled.

But for many others, high rates pose a serious challenge.

“At current lending rates, it is difficult for developments to launch new projects,” said Elena Bondarchuk, founder of warehouse developer Orientir. “The once-wide circle of investors has narrowed and those who remain are also dependent on banks’ terms.”

Lower oil prices, budget constraints and a rise in bad corporate debt are among the top economic risks facing Russia, internal documents seen by Reuters show. And Mr. Trump, though dangling the carrot of concessions over Ukraine, has threatened additional sanctions if no deal is forthcoming.

“The United States has significant leverage in terms of the economy and it’s why the Russians are happy to meet,” Chris Weafer, chief executive of Macro-Advisory Ltd., told Reuters.

“The United States is saying: ‘We can ease sanctions if you cooperate, but if you don’t we can make it a hell of a lot worse.’” — Reuters