On the weekend, it emerged that the Alternative for Germany (AfD) won 44% of the vote in state elections in Saxony-Anhalt, more than doubling its support and posting its best result to date. The Christian Democratic Union, which governed the state for many years, fell to 17.5%. AfD missed an absolute majority in the state legislature by only three seats.
The straightforward explanation for this outcome is economic. The CDU underperformed against a backdrop of tepid growth and rising energy prices, and Chancellor Friedrich Merz kept a low profile during the campaign. German retail sales plunged 3.4% month-on-month in July and were down 2.5% year-on-year; employment fell by 212,000, and inflation accelerated to 2.9% largely because of higher fuel costs. Growth has been driven by exports and defense orders rather than by household demand, and Sunday's result is a direct reckoning for that divergence.
For the euro, the significance is not the vote itself but its implications for reform. Merz's comprehensive reform package, intended to lift medium-term potential growth, now looks less secure. AfD's platform runs counter to practically every element of that package: the party calls for an end to migration, a rollback of climate policy efforts, and a rapprochement with Russia. Ending migration amid falling employment will worsen labor shortages; abandoning climate initiatives would put the energy-investment cycle at risk; and a tilt toward Russia conflicts with the logic of defense spending that underpins forecasts of acceleration to about 1.2%.
Does this mean Merz's reforms are doomed? I do not think so—these were state elections, and the federal government retains authority—but the political cost of reforms has risen. The chancellor will now have to implement unpopular structural measures, knowing each will convert into opposition support in future ballots; his own party in Saxony-Anhalt took roughly one-third of AfD's vote. That dynamic benefits those in the CDU who favor delaying painful changes and hurts investors who had priced in the reform package.
The currency market's reaction has so far been muted, largely because of the calendar. The ECB meets on Thursday in Berlin, and a rate hike to 2.5% is already widely priced; Merz himself will attend the Bundesbank dinner the evening before. Monetary developments therefore dominate political noise in the coming days since they are more concrete.
I expect the euro to dip modestly on Monday by a few tenths of a percent before attention shifts back to the central bank. The fuller effect of Sunday's vote will show up later—not immediately in exchange rate levels but in a higher risk premium on German bonds and in investors' willingness to price a reform scenario into long-term growth projections.
It is possible that growth forecasts for Germany for 2027–28 will be revised down by year-end as political uncertainty over reforms becomes a variable in economic projections.
A technical picture for EUR/USD suggests that buyers need to clear 1.1620 to target 1.1640. From there, 1.1660 is feasible, but achieving that without support from major players will be difficult. On the downside, expect significant buying only around 1.1600. If buyers are absent there, it would be prudent to wait for a fresh low at 1.1580 or to consider long positions from 1.1560.
A technical picture for GBP/USD involves that pound buyers need to clear near-term resistance at 1.3545 to target 1.3575. A break above that will be challenging. The farther target is 1.3600. On a decline, bears will try to seize control of 1.3515. If they succeed, a break of the range will inflict serious damage on bulls and push GBP/USD toward 1.3500 with the prospect of extending to 1.3480.