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Euro touches one-month high, German stocks firm

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Likely two-party coalition positive for policymaking

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Focus on whether "debt brake" can be reformed

(Writes through with election results)

By Yoruk Bahceli and Samuel Indyk

LONDON, Feb 24 (Reuters) - An election win for Germany's

conservatives eased concerns of political gridlock on Monday,

but failed to lift uncertainty around whether a new government

can deliver the fiscal reforms markets see as vital to boosting

an ailing economy.

The euro briefly touched a one-month high and stocks rose on

Monday after the conservatives looked most likely to form a

two-party coalition with the Social Democrats, which could make

policymaking easier than for the outgoing three-way coalition.

The euro rose as far as $1.0528 in Asian trading,

helped in part by a weaker dollar, but lost steam as European

markets opened with the single currency last at $1.0482, up 0.2%

on the day.

Germany's blue-chip DAX index rose 0.7% to just shy

of last week's record high.

Small- and mid-cap stocks , which have more

domestic exposure, rose 0.8% and 2%, respectively, while

Europe's STOXX 600 index edged 0.1% higher

Yields on safe-haven German bonds, which move inversely to

prices, were last unchanged.

"There is an immediate relief that there were no big nasty

surprises in the election outcome, and a centrist-leaning

government will persist and could even pivot more towards

business and investment friendly policies," said Charu Chanana,

Saxo's chief investment strategist.

The big question for markets is whether Germany can reform

the "debt brake" that limits its structural budget deficit to

just 0.35% of output.

Europe's largest economy contracted for a second straight

year in 2024, with critics blaming the debt brake for years of

underinvestment.

The conservative Christian Democrats, Social Democrats and

Greens failed to gain the two-thirds parliamentary majority

needed to change the rule. While including the Left Party would

make up the numbers, it opposes raising defence spending, which

is expected to be a major part of any fiscal boost.

"Centrist parties failed to retain a constitutional

majority, complicating the prospects of decisive fiscal regime

change," said Carmignac economist Apolline Menut.

"So tricky political compromises would be required, as well

as fiscal creativity."

The AfD, which opposes debt brake reform, did not do better

than expected, while the liberal Free Democrats, which also

oppose it, failed to enter parliament.

Expectations have been for a moderate increase in spending,

but have grown in recent days as markets assess Europe's

capacity to find potentially hundreds of billions of euros to

ramp up defence spending.

The additional yield Germany pays for longer-term borrowing

over shorter-term debt remained near its highest since 2022 on

Monday.

Debt brake reform could also support euro area stocks and

the single currency, which dropped to around $1.01 earlier in

February on U.S. tariff risks, analysts say.

(Editing by Deepa Babington & Shri Navaratnam, Kirsten Donovan)