German fiscal policy on the move
Not quite a return to reunification, but still a substantial change
Probably the most remarkable macro development in Europe over the past 6 months has been the turn-around in German fiscal policy.
Painfully too tight for several decades, under pressure from geopolitical realities the incoming Merz government instituted crucial changes to the German fiscal rules to allow for more defence spending while unleashing infrastructure spending.
All that needs to happen now is for these promises to be met. And in the past week, evidence of this change of stance has come in two forms: first, the draft 2025 budget; second, revised issuance plans.
2025-2029 budget
The German 2025 budget (only announced in the past this week due to the delays in forming a government) sees defence spending more than double by 2029, rising to €152.8 billion (to reach 3.5% of GDP).
Net borrowing is projected to increase, per the draft budget, from €33.3bn in 2024 to €81.8bn in 2025, €89.3bn in 2026, €87.5bn in 2027, €115.7bn in 2028 and €126.1 bn in 2029.
On top of this, infrastructure spending of €270bn is planned through 2029 (though the timing uncertain.)
Combined, these plans give rise to primary deficits throughout and rising debt (see below).
Issuance
Related to this, German issuance for Q3 was also revised last week. An additional €19bn will be issued in Q3 compared to previous plans. This includes an €15bn in bonds and €4bn in bills, with the bonds including new issuance of €8bn in 7-year paper.
This makes €81.5bn in bond and note issue in Q3 (compared to previously planned €66.5bn) and €37bn in bills (compared to planned €33bn.)
Gross German issuance in Q3 will therefore be €118.5bn (from €99.5bn planned previous), greater than the €108bn in Q1 and €103.5bn in Q2.
Net bund availability
Plugging these numbers into a debt sustainability framework, using the IMF’s latest WEO projections for GDP, German gross debt increases 64% of GDP in 2024 to 76% of GDP in 2029 given today’s yield curve—so a 12ppts of GDP uplift in 5 years. State and local government borrowing could add more to this—as would a higher yield curve.
Rolling 12M net issuance including this latest projection from the draft budget is shown below. While net issuance will be lower than during the pandemic and energy shock, allowing for the net Eurosystem purchases shows the increase in net free float will approach EUR250bn per year—about 5% of GDP—in the next two years.
Germany’s fiscal deficit will be above anything since reunification, excepting the recent pandemic.
Conclusion
Since the euro was formed at the turn of the millennium, one constant theme has been the unnecessary tightness of German fiscal policy—and therefore shortage of reserve asset supply from the heart of the single currency.
Geopolitical realities have shifted the narrative. At long last.
We will now get to see how the single currency works with a more sensible, if somewhat inflationary, fiscal policy from the core of the euro for the first time. Monetary policymakers ought to take this seriously—and some of them are.
The content in this piece is partly based on proprietary analysis that Exante Data does for institutional clients as part of its full macro strategy and flow analytics services. The content offered here differs significantly from Exante Data’s full service and is less technical as it aims to provide a more medium-term policy relevant perspective. The opinions and analytics expressed in this piece are those of the author alone and may not be those of Exante Data Inc. or Exante Advisors LLC. The content of this piece and the opinions expressed herein are independent of any work Exante Data Inc. or Exante Advisors LLC does and communicates to its clients.
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