Merz's economic promises suffer reality check

German Chancellor Friedrich Merz's economic reform agenda, despite a €500 billion spending pledge, is encountering significant skepticism as promised changes are deemed too slow and less ambitious by economists and business groups. Coalition friction, bureaucratic delays, and budget constraints have led to watered-down measures, exemplified by limited tax cuts and a modified supply chain law, rather than outright repeal. This failure to deliver is reflected in declining public and investor confidence, rising unemployment, and weak industrial output, raising concerns about Germany's growth prospects and potentially fueling political instability.

Analysis

The German government's economic agenda, centered on a €500 billion spending package, is facing a significant credibility gap. Despite Chancellor Merz's promises to revive growth, there is a consensus among economists and business groups that the enacted reforms are slower and less impactful than anticipated. This under-delivery is attributed to internal coalition friction, particularly with the centre-left SPD, and budget constraints, resulting in watered-down policies such as the modification, rather than repeal, of the supply chain law and smaller-than-pledged cuts to energy taxes. The macroeconomic consequences are tangible and negative: the economy contracted in the second quarter, unemployment reached a decade high of three million, and industrial output in June fell to its lowest level since 2020. This deteriorating economic picture is compounded by external pressures, including new U.S. tariffs on exporters. Consequently, both public and investor sentiment are declining, evidenced by a Forsa poll showing 61% of Germans expect worsening conditions and a drop in investor morale in August. While business sentiment shows some hope for the future, the component tracking current conditions has worsened, underscoring analyst views that meaningful economic recovery remains distant and contingent on reforms that ideological divisions may continue to obstruct.

Key Decisions for Investors

• Adopt a cautious or underweight stance on German-centric assets, as the combination of political gridlock, stalled structural reforms, and deteriorating economic indicators points to a protracted period of stagnation.
• Investors should closely monitor the German government's ability to implement promised reforms on energy costs and business taxes, as continued delays and watered-down measures will likely further dampen corporate and consumer confidence.
• Re-evaluate exposure to German export-oriented industrials, which face dual headwinds from weak foreign demand, rising Chinese competition, and new U.S. tariffs, favoring companies with strong balance sheets and diversified, non-EU revenue streams.