“The can-do attitude shown tonight could lift sentiment and pull in private investment, even before fiscal policy gets going,” added J.P. Morgan economist Greg Fuzesi, who said he expects a “material change” to Germany’s economic outlook after two straight years of recession.
No free lunch
Other things being equal, said Barclays economist Balduin Bippus, the move should reverse the downward pressure that German fiscal policy has put on the euro since 2009, when Angela Merkel introduced the debt brake. However, he added with an eye on the looming trade war with the United States,“what complicates things is that at present all else is not equal — in a rather extreme way.”
The imposition of import tariffs by the U.S., and the effect that this may have on the U.S. economy, works “at cross purposes” with the German news, making it harder to say how much higher the euro can go, Bippus said.
What is clear is that the brave new world of fiscal largesse will also have a cost. Germany’s borrowing cost surged following the announcement with the yield on the 10-year note rising more than 20 basis points to above 2.7 percent, marking the biggest jump since June 2022. That had the knock-on effect of pulling borrowing costs for all eurozone governments up in parallel. German 30-year yields were on course for their biggest one-day rise since the late 1990s.
To some, that’s an alarming reminder of why the debt brake was there in the first place. Friedrich Heinemann, an economist with the ZEW think tank in Mannheim, warned that the reform is going too far and risks debt levels spiraling out of control. He noted that, in total, the Christian Democratic Union/SPD deal would allow Germany to finance 4 percent of gross domestic product in debt at any time. “This would quickly put Germany among the highly indebted countries of the EU, and the debt-to-GDP ratio will reach 100 percent as early as 2034,” Heinemann warned.
“Today is the day when the debt brake will become history,” lamented Lars Feld, an adviser to former Finance Minister Christian Lindner, whose opposition to looser fiscal policy sparked the collapse of the last federal government.
“Germany will lose its function as a safe haven for bondholders,” Feld said. “Interest rates and inflation will not remain unaffected.”
