The Central European currencies have benefitted over the past week from the positive growth shock in Europe. German Chancellor-in-waiting Friedrich Merz outlined plans to significantly loosen fiscal policy. One part of the plan would be to set up a EUR500 billion fund for public infrastructure investment over the next decade. The second part of plan involves modifying the debt brake to allow unlimited government spending on defence as well. The German government raised defence spending to just over 2% of GDP last year.
If government spending on defence is raised further up to 3.0% or 3.5% of GDP over the next decade, it could result in another EUR500 billion plus increase in government spending. Overall, public debt as a % of GDP in Germany could increase in the ballpark of around 20ppts or higher over the next decade. It will provide a shot in the arm for the industrial sector in Germany that has been contracting over the last six years and significantly support economic growth in Europe.
We expect German GDP growth to be closer to 2.0% next year rather than 1.0%. Stronger growth in Central European countries’ main export markets provides a further tailwind for the CEE3 FX alongside recent optimism over a Ukraine peace deal. However, the plans still need to be passed through parliament and require support from the Greens.
Investor optimism on German fiscal policy has helped to put a dampener on concerns over downside risks to global growth and trade from President Trump’s tariff plans. Still the underperformance of Asian currencies over the past week still highlights that escalating trade tensions between the US and China is having a negative impact.
President Trump has now raised tariffs on imports from China by 20% which is bigger than during his whole first term. Last week’s NPC reiterated that the government plans to step up fiscal policy to support growth (click here) alongside looser monetary policy but current plans are not expected to be sufficient to prevent slower growth in the near- term. Broad-based USD weakness and falling US yields are though preventing a bigger sell-off for Asia FX.
