Germany's Social Democrats hold narrow lead in the race to succeed Angela Merkel

LONDON — Germany looks set for a three-way coalition in Berlin after one of the country's most significant federal elections in recent years.

Early projections on Sunday night point to a knife-edge result, with the center-left Social Democratic Party gaining 25.9% of the vote, according to public broadcaster ARD.

Angela Merkel's right-leaning bloc of the Christian Democratic Union and Christian Social Union is seen with 24.3% of the vote. Merkel is stepping down after 16 years as chancellor but her conservative alliance could still win power by consulting other parties and forming a coalition.

The partial results also pointed to the Green Party getting 14.5% of the vote. The liberal Free Democratic Party was seen with 11.5%, while the right-wing Alternative for Germany party was seen with 10.5%. The left-wing Die Linke party was expected to gain 5% of the vote.

Both main candidates for chancellor, the SPD's Olaf Scholz and the CDU-CSU's Armin Laschet, immediately claimed a mandate to govern after the exit polls were released on Sunday evening. But coalition negotiations, which could begin on Monday, are likely to take weeks and potentially months.

Commenting after the exit polls, Laschet conceded the result was disappointing and said it posed a "big challenge" for Germany.

"We cannot be satisfied with the results of the election," Laschet told his supporters, according to a Reuters translation.

"We will do everything possible to build a conservative-led government because Germans now need a future coalition that modernizes our country," he said.

Signaling that a coalition with just the SPD was not probable, Laschet added that "it will probably be the first time that we will have a government with three partners."

Meanwhile, the SPD's Scholz said that the party must "wait for the final results — and then we get down to work," according to Reuters.

While it's too early to state a definitive result, the projections mean the SPD or the CDU-CSU would have to form a coalition with two other parties, perhaps the Greens and FDP, to achieve a majority.

Germany experts like Holger Schmieding, chief economist at Berenberg Bank, said the exit polls did little to clarify the outlook on Germany's next leader, and the make-up of the government.

"As expected, both a Scholz-led 'traffic light' alliance of the 'red' SPD with the Greens and the 'yellow' liberal FDP and a 'Jamaica' coalition of Laschet's 'black' CDU-CSU with Greens and FDP are possible. SPD and Greens, who are close, would likely extend an offer to the FDP whereas CDU-CSU and FDP, who are also close, would try to get the Greens on board," Schmieding said in a research note Sunday evening.

To get the Greens on board in a so-called "Jamaica" coalition (so named because the colors of the parties involved replicate those of the Jamaican flag) the CDU-CSU could have to make concessions to the Greens, and more than the bloc might be willing to stomach, Schmieding noted.

While the next chancellor of Germany remains a mystery for now, the projections seem to dispel investor fears that the country could end up with a coalition of the SPD, the left-leaning Die Linke and the Greens, an alliance in government which, Schmieding stated, "could have impaired trend growth through tax hikes, reform reversals and excessive regulations."

"If the official results confirm the exit polls — a big if as the results are close and the high share of postal voters of up to 50% may make the exit polls less reliable than usual — we would breathe a big sigh of relief. Until the exit polls, we had attached a 20% risk to such a tail risk scenario," he said.

Speaking to CNBC's Annette Weisbach on Sunday evening, Florian Toncar, a lawmaker for the pro-business FDP said "one good aspect of today's outcome is that a left coalition including the far-left [Die Linke] has probably no majority, so that facilitates things a lot.

The election is significant because it heralds the departure of Merkel, who is preparing to leave office after 16 years as leader.

Recent German elections had failed to throw up any real surprises with Merkel's re-election relatively assured. But this election race has differed by being wide open and too close to call, even up to the last days before the vote.

The Green Party enjoyed a bounce in popularity and took the lead in the polls at one point in April to then be overtaken by the Social Democratic Party, which managed to hang on to a slight lead in recent weeks.

Merkel's ruling conservative alliance of the Christian Democratic Union and Christian Social Union had failed to galvanize Germans, and around 40% of voters were reported to be undecided as to who to vote for in the week ahead of the election.

The CDU, and its Bavarian sister party, the CSU, have dominated German politics since 1949, when the parties formed a parliamentary group and ran in the first federal election following World War II.

In recent years the party has fallen out of favor with younger German voters who are prioritizing green policies and want to see Germany invest in and modernize its creaking industries and infrastructure.

Voting took place all day Sunday, from 8 a.m. to 6 p.m. local time, in polling stations around the country although a large proportion of voters opted for postal ballots this election, given the coronavirus pandemic.