- Germany’s economy has stagnated post-Covid, with structural weaknesses and energy shocks worsening the slowdown
- A new coalition government under Friedrich Merz will take office in March, aiming for economic revitalisation despite fiscal constraints
- Defence spending is set to rise due to NATO pressure, potentially requiring modifications to Germany’s strict debt rules
- Germany's IfW economic institute has revised its 2026 growth forecast for Europe's largest economy to 1.5% from 0.9%, citing expected benefits from increased public spending
- Germany’s stock market has shown resilience, with optimism growing after a recent DAX breakout, potentially supporting broader European markets
Challenges, opportunities, and the path to economic renewal. Germany, the world’s third-largest economy after the US and China, boasts a highly advanced, export-driven industrial sector specialising in automotive, chemicals, engineering, and research. However, structural weaknesses have become increasingly apparent due to global shifts such as digitalisation, rising trade protectionism, and intensified competition from China. Additionally, the Ukraine-Russia conflict has triggered energy supply shocks, leading to the decline of energy-intensive industries. As a result, Germany’s economy has stagnated post-Covid, contracting by approximately 5% compared to where it would have been had pre-pandemic growth trends continued.
New government, new possibilities. A new coalition government, led by Friedrich Merz, is set to take office at the end of March, following two consecutive years of negative GDP growth. This transition creates a strong impetus for economic revitalisation. A bold, transformative strategy may be necessary to address Germany’s structural challenges, as these issues will not resolve themselves. However, investment spending remains constrained by the debt brake—a constitutional rule introduced in 2009 that limits the annual budget deficit to 0.35% of GDP.
Rising defence spending and fiscal constraints. During the recent Ukraine-Russia peace talks, NATO members faced pressure from former US President Trump to allocate at least 3% — and potentially up to 5% — of GDP to defence. Accommodating this expenditure may require modifying Germany’s debt brake. Current proposals include off-budget spending and an EUR800bn infrastructure fund exempt from debt constraints.
Urgency and political challenges. Germany must approve any such measures before the Bundestag’s new session on 25 Mar. However, the results of the 23 Feb elections complicate this effort. The CDU/CSU, Social Democrats, and the indecisive Green Party lack the two-thirds majority required for a constitutional amendment. Meanwhile, the far-right Alternative for Germany (AfD), which has doubled its representation, opposes the ReArm EU plan if it involves increased national debt or relaxed fiscal rules. The AfD has even petitioned the Federal Constitutional Court to block major fiscal decisions by the outgoing Bundestag, arguing that they bypass the electorate’s latest mandate. Given the fragmented coalition, negotiations to lift the debt brake will be challenging—but not impossible. Germany's IfW economic institute has revised its 2026 growth forecast for Europe's largest economy upward, citing expected benefits from increased public spending.
A shift in fiscal strategy. Increasing debt would mark a significant departure from Germany’s traditionally conservative fiscal policies, signalling a shift toward a more pragmatic, investment-driven strategy. If managed wisely, this could enhance economic resilience, strengthen technological leadership, and bolster Germany’s influence in shaping European and global economic policies.
A shift toward higher debt levels in Germany could also set a precedent for the European Union (EU). Germany’s historically cautious fiscal stance has significantly influenced EU policies, particularly through the Stability and Growth Pact. A more flexible German approach could pave the way for looser EU-wide debt and deficit rules, fostering greater coordination in European investment efforts.
Growing stock market optimism. The Deutsche Börse is well-diversified across sectors such as insurance, energy, defence, telecommunications, and technology. The top 10 stocks collectively account for 61% of the DAX 40’s total market capitalisation, with strong representation in preferred sectors such as technology, healthcare, and industrials. With the recent breakout in the DAX index, there is growing optimism that Germany’s economic downturn may have reached its nadir. As the second-largest stock market in the Eurozone after France, Germany’s market performance could provide a boost to the broader STOXX Index.
Europe raised to Overweight. In response to the new fiscal stance and the positive momentum it brings, we are upgrading the Eurozone to Overweight on a 3-month tactical basis. However, pending further developments in the Ukraine-Russia ceasefire talks and the implementation of fiscal expansion, we are maintaining a 12-month Underweight in the Eurozone due to its structural weaknesses. Our preferred sectors are technology, healthcare, industrials, and luxury.
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