Germany’s recent fiscal overhaul is sending shockwaves through financial markets, lifting the euro, and causing borrowing costs to spike. The euro surged 0.7% against the dollar to reach 1.0722, its highest level since November 2024, following an announcement about a major spending package led by Chancellor-in-waiting Friedrich Merz. This plan includes a €500 billion fund for defense and infrastructure spending over the next decade, signaling a drastic shift from Germany’s traditional budget policies.
The spending plan aims to bypass the country’s constitutional debt limits, known as the “debt brake,” which has been a cornerstone of German fiscal policy for years. The proposed deal, still subject to parliamentary approval, is expected to push Germany’s borrowing costs higher, with the 10-year government bond yields jumping nearly 25 basis points to their highest point in 17 months.
This new approach to government spending comes as European Commission President Ursula von der Leyen has also proposed a significant defense funding boost, reflecting the region’s growing focus on military readiness amid ongoing geopolitical tensions. Experts are calling this a pivotal moment for Germany’s economy, with some predicting it could help reverse the country’s recent economic stagnation.
However, the decision to increase spending has sparked concern among economists about potential long-term risks. The move could put Germany on track to reach a debt-to-GDP ratio of 100% by 2034, a development some experts warn could have negative implications for Europe’s fiscal stability. Critics also argue that the increased borrowing costs could outweigh the benefits of the proposed fiscal stimulus.
Despite these risks, market reactions have largely been positive, with analysts predicting continued strength for the euro. Deutsche Bank’s George Saravelos forecasts the euro may continue rising until it hits 1.10 against the dollar. However, some analysts caution that the broader economic context, including the ongoing trade tensions with the U.S., could complicate the outlook for Germany’s fiscal plans.
While Merz’s ambitious plan has not yet passed through parliament, it marks a significant shift in Germany’s approach to fiscal policy, moving away from austerity and signaling a more aggressive stance on defense and infrastructure investment. If the plan gains approval, it could change the course of Germany’s economic policy and its role within the broader European Union.