German Chancellor Friedrich Merz’s Christian Democratic Union (CDU) suffered clear defeats in two state elections held on Sunday, adding a political risk factor to a European market already focused on oil prices, inflation expectations and central-bank decisions. Brent crude extended its decline, while Asian equities and European and US equity futures moved higher. Rising pressure on Germany’s government could nevertheless affect the risk premium on euro-denominated assets.
CDU Falls Short in Mecklenburg-Vorpommern
Preliminary results showed the CDU receiving 4.9% of the vote in Mecklenburg-Vorpommern, below the 5% threshold required to enter the state parliament. In Berlin, the party won 18.8%. Merz called the result in the northeastern state a “disaster”, but said he would remain chancellor and continue with his planned reform agenda.
In Mecklenburg-Vorpommern, the right-wing Alternative for Germany (AfD) led with 38.2% of the vote, ahead of the Social Democratic Party (SPD) on 35.5%. Other parties had previously ruled out forming a governing coalition with the AfD, limiting the party’s prospects of entering the state government. In Berlin, Die Linke won the largest share, at 25.7%.
The results do not indicate an immediate collapse of Germany’s federal government, but they increase pressure on Merz within both the governing coalition and his own party. Markets will focus on whether the setbacks lead to discussion of a change in chancellor or weaken the federal government’s ability to advance fiscal, economic and industrial reforms. A further build-up of political uncertainty could increase the political risk premium on euro assets.
Brent Retreats as Supply Fears Ease
Brent crude fell below $102 a barrel in early trading on Monday, extending last week’s decline. Investors were again assessing the possibility of renewed diplomatic contact between the United States and Iran. Washington and Tehran continued to exchange threats over the weekend, but US President Donald Trump said he might meet Iranian President Masoud Pezeshkian during the United Nations General Assembly this week.
Tensions in the Middle East have not fully subsided. The Houthi movement said it attacked sensitive facilities in Riyadh and a Saudi Aramco site in Yanbu over the weekend. However, shipping traffic through the Strait of Hormuz has increased and Saudi Arabia has partially resumed exports, reducing immediate concerns about supply disruptions and narrowing the geopolitical premium embedded in crude prices.
If shipping through the Strait of Hormuz remains uninterrupted and US-Iranian relations show further signs of easing, lower energy prices could support broader risk appetite. Equity performance last week illustrated that transmission mechanism: defensive, low-volatility and value stocks outperformed during the initial rise in oil prices, while cyclical, growth, momentum and large-cap stocks regained support as crude prices retreated. Healthcare and technology were among the strongest-performing sectors over the full week.
PMI Data and Nordic Rate Decisions Ahead
In Sweden, Origo is due to publish its third-quarter survey of inflation and wage expectations this week. In its August monthly survey, one-year inflation expectations rose to 1.97% from 1.83%, while two-year expectations increased to 2.07% from 2.02%.
Flash September purchasing managers’ indices for major economies, due on Wednesday, will be a key data release. Stronger summer growth in the euro area has reopened discussion about the scope for further tightening by the European Central Bank. Investors will therefore examine whether manufacturing momentum is continuing to improve.
The Norges Bank and Riksbank will announce their rate decisions on Thursday. Market pricing and economist expectations for Norway are broadly split between a rate increase and no change. The central scenario is that Norges Bank will keep its policy rate at 4.25% while retaining the possibility of another increase. Sweden’s central bank may leave its policy rate at 1.75%, but its wording could signal a rate increase in the fourth quarter.
Inflation Expectations and Manufacturing Diverge
The European Central Bank’s consumer survey showed median one-year inflation expectations in the euro area rising to 3.0% year on year in August, while three-year expectations increased to 2.9%. Expectations, which had declined steadily since May, have temporarily stabilised at around 3%. The ECB may view that change as a modestly hawkish signal.
US industrial production was weaker than expected in August. Total output was unchanged month on month, against a market forecast for a 0.3% increase and a previous 0.2% rise. Manufacturing output fell 0.3%, compared with expectations for a 0.3% increase and a previous 0.2% gain. Manufacturing production ended a seven-month run of growth, with durable goods the main drag.
Capacity utilisation held at 76.3%, just below the 76.4% market forecast and well below its long-term average of 79.4%. The data suggest that US manufacturing activity may be slowing from its stronger first-half performance as energy prices and interest rates rise.
In China, the People’s Bank of China left its loan prime rates unchanged, keeping the one-year LPR at 3.0% and the five-year LPR at 3.5%, in line with market expectations. Stable LPR settings indicate that current economic support is relying more heavily on fiscal measures than on another reduction in lending benchmarks.
Treasury Yields Rise as Swedish Krona Weakens
US Treasuries posted a bear-flattening move on Friday, extending the repricing that followed the Federal Reserve’s policy meeting. Two-year and intermediate-maturity yields rose by roughly 7 to 8 basis points, with the two-year Treasury yield closing at 4.74%, its highest level since July 2024.
European rates also moved higher. Rising energy prices and a marked deterioration in French sovereign risk pushed Germany’s two-year Bund yield up by 5 to 6 basis points to 3.28%. The 10-year yield rose 5 basis points to 3.52%. EUR/USD traded below 1.15 on Friday, while the impact of energy-price moves on the currency remained limited.
Nordic currencies diverged. EUR/SEK rose to around 11.30, a one-year high, leaving the Swedish krona under continued pressure. EUR/NOK was broadly stable near 10.80. For now, the main market drivers remain changes in oil prices, the repricing of US and European interest rates, and how the Nordic central banks describe their policy paths this week.