Germany's fiscal future in balance as election looms

Next week, elections will be held in Germany following the loss of parliamentary majority by the current chancellor, Olaf Scholz. Market analysts emphasise the necessity of enhancing public spending in Europe's largest economy. According to estimates by Goldman Sachs, the German economy has stagnated since 2019, while the eurozone has experienced a 5% growth, and the United States an 11% increase.

Germany is the only country within the G7 group whose public debt remains notably below 100% of GDP. In contrast to concerns about high debt levels in the United States, the United Kingdom, and France, investors are encouraging Germany to increase its debt level to unlock its economic growth potential.

Financial markets are particularly interested in the potential relaxation of the German expenditure rule, which effectively limits new borrowing. This issue gains further significance in the light of US tariffs that could adversely affect the already weakened German economy and the necessity to boost defence spending.

According to a January survey by Bank of America, nearly two-thirds of investors anticipate only a slight relaxation of the debt brake. Nicola Mai of PIMCO, one of the largest bond funds, describes the current debt brake rule as a "straitjacket" and highlights Germany's capacity to increase its debt.

Friedrich Merz, the likely future chancellor and leader of the conservatives, has shown some openness to limited reform of the debt brake. At present, this rule restricts the structural deficit to 0.35% of GDP. According to a December survey by Citi, the bank's clients regard raising this limit to 1% as the most probable scenario, Reuters reports.

The yield on German 10-year treasury bonds exceeded the interest rate swaps last year, partly due to expectations of higher issuance following the government's collapse in November. However, bond yields have risen only slightly since then, suggesting that markets perceive higher spending as manageable.

The significance of the outcome of the German elections is also discussed in a report by Saxo Bank. John J. Hardy, the chief macroeconomic strategist, emphasises that it is crucial for the new chancellor to form a coalition that enables a more flexible fiscal policy, setting aside concerns about debt limits.

The greatest chances seem to lie with another "grand coalition" with the SPD, although there is potential for cooperation with the "Greens", a party focusing on environmental protection and sustainable development. Both options could be beneficial for the euro, provided the coalition is strong enough to avoid obstructions from other parties. Additionally, the role of the EU in shaping the agreement's conditions and its consequences will be significant, states Hardy.

According to the latest forecasts from the Ifo Institute, Germany is expected to have the weakest economic growth among developed countries in 2025. Niklas Potrafke from the Ifo Institute points to the drastic decline in Germany's attractiveness and calls for urgent market reforms.

Projections for the German economy indicate minimal growth, with expected increases of 1% in 2026 and 1.3% in 2028. Global economic prospects for 2025 are more optimistic, with projected growth of 2.9% compared to 2.6% in 2024.

The highest growth is anticipated in Africa (3.9%) and Asia (3.8%), while Europe (2.1%) and North America (2.4%) are expected to see lower figures. Particularly high growth is forecasted for West Africa (5.6%) and Central Asia (5.1%).

In the long-term perspective, the global economy is expected to grow at a rate of 3.2% in 2026 and 3.1% in 2028. These figures are derived from a survey conducted in December 2024, involving 1,398 economic experts from 125 countries. Experts also note that in some countries, such as China, Argentina, Spain, and the Netherlands, growth may remain stable or decrease.