What does the German ‘fiscal bazooka’ mean for Europe?

Hot on the heels of the European Commission’s ‘ReArm Europe Plan’, enabling over €800 billion in defence spending, the German federal parliament’s approval of incoming chancellor Friedrich Merz's massive spending increases represent a historic shift in its economic policy.

It abandons decades of fiscal conservatism to implement a €500 billion infrastructure fund and increased defence spending exempt from its constitutional debt brake, or ‘Schuldenbremse’. Established in 2009 to limit the amount of new borrowing by the federal and state governments, the debt brake was designed to ensure long-term fiscal sustainability and stability.

Deploying €500 billion over 10 years, the package is equivalent to 11.6% of GDP in 2024¹. Following years of underinvestment, it could lead to more than €1 trillion in spending over the next decade, potentially revitalising Germany's economic model and generating positive economic spillovers across Europe¹. Indeed, having been in recession territory for the past two years, Germany's GDP is expected to see a 0.7% increase in 2026².

However, there’s potential for higher interest rates across the eurozone as the European Central Bank (ECB) seeks to reduce its balance sheet. Moreover, some worry about the pressure on bund yields because of increased government spending and future bond issuance. If the German deficit was to widen, it could result in an additional funding requirement of between €50 billion and €70 billion for 2026². Can the market absorb this issuance without requiring an additional premium to do so?