German cabinet passes 2025 draft budget with leap in defence spending

Germany's cabinet approved a 2025 draft budget and 2026 framework, earmarking record investments of €115.7 billion in 2025 (up from €74.5 billion in 2024) and significantly boosting defence spending to 3.5% of economic output by 2029. This fiscal expansion, funded by a substantial borrowing program, aims to stimulate economic growth and reinforce Germany's defence capabilities ahead of a key NATO summit. The plan projects interest payments on debt to more than double by 2029, prompting an immediate rise in German government bond yields as investors factored in increased borrowing, signaling a notable shift in the nation's fiscal and security priorities.

Analysis

Germany's cabinet has approved a 2025 draft budget that signals a significant pivot from fiscal conservatism towards large-scale, debt-funded expansion. The plan allocates a record €115.7 billion for investments in 2025, a substantial increase from €74.5 billion in 2024, aimed at reviving an economy that has contracted for two consecutive years. A central feature is the dramatic increase in defence spending, projected to rise from 2.1% of GDP in 2024 to 3.5% by 2029, funded through a nearly €400-billion borrowing program. This fiscal stimulus will be financed by a total borrowing of €847 billion over the next five years across various funds. The market has reacted immediately to the increased debt supply, with Germany's 10-year and 30-year bond yields rising by 5 and 8 basis points, respectively. The long-term fiscal impact is notable, as interest payments on debt are forecast to more than double from €30.2 billion in 2025 to €61.9 billion by 2029, at which point they would constitute over 10% of the total budget.

Key Decisions for Investors

• Investors should anticipate continued upward pressure on German bond yields and may consider underweighting long-duration German sovereign debt due to the substantial increase in planned government borrowing.
• Consider overweight positions in European defence contractors and German infrastructure-related companies, as these sectors are direct beneficiaries of the government's explicit and large-scale spending commitments.
• Closely monitor the trajectory of Germany's debt service costs as a key risk factor, as the projected doubling of interest payments by 2029 could impact the nation's long-term fiscal sustainability and sovereign risk premium.