New German government faces rising markets but debt brake is a barrier

Sunday's elections come at a time of economic and political uncertainty for Germany. The GDP of Europe's largest economy contracted for the second year running in 2024, while forecasts point to marginal growth for this year, so the context is far from favourable.

At the same time, it is known that the debt brake marked the political and economic agenda of the last legislature, by limiting public investment in a turbulent period for the largest economy in the euro zone.

Markets react to the results this Monday and eyes also focus on the future decisions of the next government, along with their impact on financial stability, the stock markets and the international perception of Europe's economic engine.

It is against this backdrop that the main German index (DAX) has seen an increase of over 13% since the beginning of the year and reached a record high on Wednesday morning, before falling back slightly on the eve of the elections held on Sunday.

The figures reflect investor confidence in the companies listed on the index, despite the difficulties experienced in several sectors of the German economy, which are notorious, for example in the automotive sector. On the other hand, recent developments on a global scale have given strength to another aspect, which also has a significant impact on European markets.

Defense sector takes Germany to new highs

The geopolitical context, with the warnings made by Donald Trump regarding the war between Ukraine and Russia, generated an alert in Brussels and increases in the value of certain European listed companies in the Defense sector.

The European Commission has set a target for investment in defence of around 2% of their respective GDPs, and Member States are being forced to respond to the position taken by the US president. This idea suggests that several companies will make greater investments, with support from countries seeking to strengthen the protection of their borders.

It was with this in mind that markets reacted to Trump's words last Monday. The 14% rise in the market price of Rheinmetall and 19% in Thyssenkrupp, both listed on the Frankfurt stock exchange, reflected a buoyant German defense market.

What is the debt brake and what is it for?

Germany is facing a difficult economic climate, while at the same time losing ground in the global economy, similar to what is happening in the eurozone. One of the possibilities that has been discussed to reverse this trend is to increase investment by the German state, which is why a political debate is being raised about the debt brake.

The issue at stake is a rule that limits the German budget deficit to less than 0.35% of nominal GDP. This means that the government in power, whatever it may be, is limited in the volume of state expenditure and, consequently, in the stimulus it can launch from a budgetary and monetary point of view.