Germany’s election results brought a glimmer of optimism to sluggish markets at the start of the week, but questions remain over whether the new government can deliver on its promises to increase public spending and revive the economy.

Frankfurt’s DAX rose 0.6% on Monday, outpacing a flat FTSE 100 in the UK and a 0.78% drop in France’s CAC 40, as the euro edged higher against the dollar and sterling, and German borrowing costs barely changed.

Sunday’s election results showed a win for the conservative coalition of the Christian Democratic Union (CDU) and the Christian Social Union (CSU). This means that CDU-CSU candidate Friedrich Merz will almost certainly take over as the next chancellor. Merz is a center-right pro-business politician who currently sits on the boards of EY Germany and Deutsche Börse.

However, some uncertainty remains, with a period of coalition negotiations ahead and the need for support from smaller parties to implement promised policies, including a reform of Germany’s controversial “debt brake” rules.

“I think what the market is seeing now is some kind of stability, at least we know who won the election, we know who claimed victory, and then we know who the coalition will be centered around,” Michael Field, chief equity strategist at Morningstar, told CNBC’s “Squawk Box Europe” on Monday. “So I think the market is viewing this as a huge positive.”

A worse market outcome could result in the CDU not being able to reach the level needed to form a coalition, triggering “months of chaos, scrambling and uncertainty about the business outlook,” Field said.

The outcome is good for the German economy because a two-party “grand coalition” between the Conservatives and the Social Democrats (SPD) now looks possible, a scenario that would speed up decision-making, Danske Bank analysts said in a note.

Whether it’s a two- or three-party coalition and bringing in smaller parties like the Greens — Merz has ruled out governing with the second-place far-right Alternative for Germany — the major parties are aligned on policies like lower energy prices and more infrastructure investment, which would “have a positive impact on business,” Field of Morningstar told CNBC.

Field said the move could provide a boost to sectors such as Germany’s auto industry, a once-mighty industry that has been hit by competition from Chinese electric vehicles, weak domestic demand, U.S. tariff threats and regulation.

“The industry has been hit hard… Our position is that it doesn’t take a lot to turn that around and move it a little bit in a positive direction, and the new government has the power to really lower energy prices and try to make the economy more competitive, and any concessions could really give the industry a much-needed boost right now,” Field said.

The easily overlooked utilities sector is another area that could benefit if the government removes policies such as energy price caps and consumer energy taxes that limit market returns, Field went on to say.

The government needs to develop a long-term agenda to restructure Germany over the next five years, Siemens Energy Chairman Joe Kaiser told CNBC on Monday. That agenda needs to focus on the economy, infrastructure, energy, education, innovation, restructuring the pension system and “taking back control of government and government reform.”

Meanwhile, Arnd Franz, CEO of auto parts maker Mahle, told CNBC that the manufacturing sector needs urgent action on taxes, energy costs and labor market flexibility.

In a note on Monday, Citi analysts stressed that “the post-election policy landscape will depend on the shape of the yet-to-be-formed coalition government.”

They highlighted the potential market impact of smaller parties and said the Greens joining the coalition would be a positive for construction companies that produce heating and cooling equipment, as it would reduce the likelihood of removing subsidies and mandates for heat pump retrofits.

The Citi analysts also said they see “limited medium-term risks to Germany’s onshore wind auction system,” citing the Christian Democratic Union’s platform as arguing that now is the time to “develop the grid, storage facilities and all renewable energy sources.”

“This seems to imply that no major measures will be taken to hinder wind power development,” Citi said, supporting stocks such as Nordex and Vestas, they wrote.

However, key issues that remain for the market to watch include whether the government can get the economy back to growth, rebuild weak business and consumer confidence, and increase fiscal spending by removing constitutional provisions that limit the amount of government debt. The latter point has become a wider focus in recent weeks as European countries discuss increasing defence spending in response to the Russia-Ukraine war and tensions with the US

“The key result from a market perspective is that … the three major establishment parties (Union/CSU, SPD and Greens) did not secure the two-thirds majority needed to amend the constitution,” Rabobank’s economic research team said on Monday.

Therefore, there is no clear path to passing reforms, with the AfD opposing the removal of the debt brake, while the Left is open to it but at odds with the SPD and opposes arming Ukraine.

“Most importantly, yesterday’s election results do not provide a clear path to amending the constitution to allow for a significant shift in government spending,” Rabobank said.

In the absence of a major fiscal shift, the outlook for growth in Germany and the surrounding region “remains very bleak,” they added.
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