German borrowing costs surged by the most since the fall of the Berlin Wall as a pledge to do ‘whatever it takes’ to boost its defences sent its bonds into free fall.
In what was described as a ‘seismic’ and ‘historic’ shift in policy, chancellor-in-waiting Friedrich Merz outlined plans to exclude military spending from the country’s stringent ‘debt brake’ rule to free cash for a massive rearmament programme.
He set out plans to create a £400billion fund to upgrade German infrastructure and revive the ailing economy.
‘A really big bazooka. A fiscal sea change for Germany,’ said Holger Schmieding, chief economist at Berenberg Bank, the country’s oldest bank.
The price of German bunds – parcels of government debt – fell as investors weighed up the plans.
That sent the yield on ten-year bunds – a key measure of borrowing costs which rise when the price falls – up from around 2.5 per cent to 2.8 per cent.
Borrowing costs: The price of German bunds tumbled sending the yield on ten-year bunds up from around 2.5% to 2.8%
It was the biggest rise in yields since March 1990 – in the aftermath of the fall of the Berlin Wall in 1989 – when West and East Germany were in the process of reunification. ‘It’s clearly a big change.
The market is pricing in fiscal risk,’ said MFS Investment Management’s Annalisa Piazza.
Merz said radical action was needed given Europe can no longer rely on the US for defence and security under Donald Trump.
‘In view of the threats to our freedom and peace on our continent, the rule for our defence now has to be “whatever it takes”,’ he said.
Deutsche Bank economists described it as ‘one of the most historic paradigm shifts in German post-war history’.
The euro soared against the dollar – rising nearly 2 per cent to a four-month high close to $1.08 – while the pound was also at a four-month high – at just below $1.29.
And borrowing costs across Europe rose with the UK ten-year gilt yield topping 4.7 per cent for the first time since mid-January in a headache for Rachel Reeves ahead of this month’s Budget.
Rising bond yields as well as weak economic growth – and demands for higher defence spending – have left her facing tax rises or spending cuts to meet her fiscal rules. ‘Germany has done something quite radical,’ noted Bank of England Governor Andrew Bailey.
‘Seismic shift’: Germany’s Chancellor-in-waiting Friedrich Merz (pictured) outlined plans to exclude military spending from the country’s stringent ‘debt brake’ rule to free up cash
The proposals by Merz, whose Christian Democrats are seeking to lead a coalition government after emerging as the largest party in last month’s elections, could be a turning point for the European economy after decades in which Berlin has been criticised for holding back growth through its excessive budgetary thrift.
James Bilson, a strategist at Schroders, said: ‘Eurozone policymaking often exhibits a familiar pattern – reactive, bureaucratic, frankly ponderous at times.
‘But once the political will is reached and the Rubicon is crossed, it has the ability to be seismic, creating a sea-change in markets.’
Jim Reid, at Deutsche Bank, said the ‘shock and awe fiscal stimulus’ was ‘one of the largest fiscal regime shifts in post-war history’, adding: ‘Everything you thought you knew about Germany’s economic prospects three months ago, or even three weeks ago, should be ripped up.’
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