Chancellor-to-be Friedrich Merz has agreed a deal with his likely coalition partner to inject hundreds of billions in extra funding into Germany’s military and infrastructure, in a “fiscal sea-change” designed to revive and re-arm Europe’s largest economy.
In an announcement that came just over a week after he won federal elections, Merz said late on Tuesday that his Christian Democratic Union (CDU), its Bavarian sister party and the rival Social Democrats (SPD) will jointly present a bill in parliament next week to relax the country’s strict borrowing rules.
A provision would exempt defence spending above 1 per cent of GDP from the “debt brake” that caps government borrowing, allowing Germany to raise an unlimited amount of debt to fund its armed forces and to provide military assistance to Ukraine.
The future coalition partners will introduce another constitutional amendment to set up a €500bn fund for infrastructure, which would run over 10 years. They are also planning to loosen debt rules for states.
The news triggered the biggest sell-off in German government debt since 2020 on Wednesday, as investors braced themselves for a significant increase in borrowing. The yield on the 10-year bund, a benchmark for the eurozone, jumped 0.19 percentage points to 2.67 per cent in early trading.
“This fiscal sea change will permanently alter the way that bunds are trading,” said Tomasz Wieladek, chief European economist at asset manager T Rowe Price, adding that higher yields will “raise the financing costs for all other sovereigns in the euro area significantly”.
Germany’s massive fiscal stimulus has also underlined the sense of urgency in Europe, spurred by US President Donald Trump’s threat to unwind the US guarantees that have long underpinned the continent’s security.
“This is a fiscal sea-change for Germany,” said Holger Schmieding, chief economist at Berenberg. “Merz and his coalition-to-be are rising to the occasion.”
Echoing Mario Draghi’s vow to defend the Eurozone in 2012 when he was president of the European Central Bank, Merz said Germany would do “whatever it takes” to fend off “threats to freedom and peace” in Europe.
Standing alongside party leaders from the SPD and Bavaria’s Christian Social Union at a press conference in Berlin, Merz said the package would also boost Germany’s flagging economy, which has suffered from two years of stagnation after decades of under-investment in railways, roads, bridges and communications infrastructure.
“The additional spending on defence can only be coped with if our economy returns to stable growth within a very short period of time . . . This requires rapid and sustainable investments in our infrastructure.”
The bills need a two-thirds majority in parliament to pass, which means Merz will have to reconvene the outgoing Bundestag that was elected in 2021 — and secure the backing of the Greens.
The plan marks a stunning shift in Germany’s traditionally conservative stance on fiscal stimulus. Berlin enshrined the debt brake in its constitution in 2009, which limits government borrowing and keeps the structural deficit at 0.35 per cent of GDP.
Defence specialists and economists welcomed Merz’s decisive step.
Jana Puglierin, a senior policy fellow at the European Council on Foreign Relations, said: “It is a huge investment in Germany‘s ability to act — and potentially in Europe’s [ability to act] if Germany finds its way back to being a constructive European leader.”
Liana Fix, a fellow for Europe at the Washington-based Council on Foreign Relations, said the move marked a “real Zeitenwende” — a watershed moment — of the kind that outgoing chancellor Olaf Scholz had promised as he unveiled a €100bn defence fund in the wake of Russia’s full-scale invasion of Ukraine in 2022.
Merz’s conservative CDU/CSU had opposed reforms to the debt brake before the February 23 election. However, hours after coming first in the nationwide vote, the staunch transatlanticist declared that Europe needed to achieve “independence” from Washington given that Trump appeared “largely indifferent” to Europe’s fate.
Jens Südekum, a professor of international economics at Düsseldorf’s Heinrich Heine University who had urged Merz to reform the debt brake, described the announcement as “a total game-changer”.
Merz has accelerated coalition talks with the SPD since Trump publicly admonished Ukraine’s President Volodymyr Zelenskyy at the White House last week. The US president’s decision this week to suspend military assistance to Kyiv, which stunned Ukrainian authorities and their European allies, only added to the sense of urgency.
Exempting defence spending from debt rules “is a sensible approach that didn’t seem possible only days ago,” Henning Meyer, a professor at Tübingen university who is close to the SPD. Defence “doesn’t lend itself for a defined special fund. You just don’t know how much you’ll need and in which timeframe,” he said.
Puglierin said Merz was “taking a big personal risk” by moving so rapidly from his campaign statements.
“He is only doing this so quickly and so decisively because he really does see an absolute emergency situation for Germany and Europe,” she said. “Without the actions of the Trump administration in recent weeks, this would not have been possible.”
The preliminary deal paves the way for a broader coalition agreement with the SPD. Germany’s next chancellor wants to use the outgoing parliament’s supermajority to pass the constitutional amendments because his government would probably be blocked in the next parliament by the far-right Alternative for Germany and far-left Die Linke.
The current parliament can be convened until March 25, before new MPs can take their seats.
Merz’s deal with the SPD came as the European Commission outlined on Tuesday a joint debt instrument that would enable member states to fund the purchase of military equipment.