When Germany enshrined a ‘debt brake’ in its constitution in 2009, it was considered a victory for fiscal rectitude. As a protection mechanism against profligacy on the part of the state, it reflects the German anathema to debt.
The debt brake limits the federal government’s structural deficit to 0.35% of gross domestic product, adjusted for the economic cycle. It effectively prohibits Germany’s 16 federal states from running any budget deficits at all.
Today, as our graph of the week shows, Germany’s debt-to-GDP ratio is among the lowest in the eurozone. But pressure is rising on eurozone countries, and on Germany in particular to increase defence spending. Frederich Merz, the leading contender in the federal election on 23 February, has said he is open to reforming the country’s debt rules.
Merz has also said he is open to discussions about common European Union borrowing for defence, a topic that is back on the agenda as the eurozone responds to the risk of fading US engagement in European defence.
A new chapter may be opening for Europe, with fiscal expansion in Germany and easier monetary policies from the European Central Bank. This combination would favour yield-curve steepening.
Given that reform of the debt brake requires a two-thirds majority in parliament, it will take time. Our eurozone bond team remains overweight German government debt, until they are sure there really is going to be more of it.
