Germany takes its foot off the spending brake

What’s going on here?

German Chancellor Friedrich Merz is set to unveil ambitious spending plans – including a heavy boost to the defense budget and a serious investment in infrastructure.

What does this mean?

Germany's shift to increase defense spending could have widespread implications – not just locally, but across the EU. The plans would see any defense spending above 1% of the economy's annual output become exempt from the constitutional debt brake, and would also call for the creation of a €500 billion ($538 billion) special fund to finance infrastructure upgrades over the next decade.

That's big: Germany spent 2.1% of its output on defense last year, and some rough-and-ready estimates suggest that could rise to 3% over the coming couple of years. Even more impactful could be the creation of that infrastructure fund, which could stimulate the economy as project timelines advance. The forecasts hint at an economic uptick of as much as 1 percentage point – which could potentially prompt other nations in the bloc to reevaluate their spending constraints, particularly if the EU adopts a similar relaxed stance on government spending. Already, rising Bund yields indicate market anticipation of stronger growth and reflect higher term premiums thanks to increased debt supply, while the European Central Bank may continue rate adjustments to balance these economic shifts.

Why should I care?

For markets: Germany’s making fiscal moves.

As Germany embarks on this spending spree, investors should keep an eye on bond markets, where Bund yields have already reacted. Watch for potential ripple effects across the eurozone, as increased German spending could spur similar initiatives, potentially redefining investor sentiment and reshaping market landscapes.

The bigger picture: European spending strategies could be at a tipping point.

Germany's push for higher defense and infrastructure investments might set a precedent for the EU as a whole. If exemptions for defense spending become widespread, expect a recalibrated EU fiscal policy landscape, influencing global market perceptions and strategic economic planning across member states.

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