German parties agree on historic debt overhaul to revamp military

The parties hoping to form Germany's next government on Tuesday agreed to create a 500 billion euro infrastructure fund and overhaul borrowing rules in a tectonic spending shift to revamp the military and revive growth in Europe's largest economy.

Friedrich Merz's conservatives and the Social Democrats (SPD), who are in negotiations to form a coalition after a national election last month, will put their proposals to the German parliament next week.

Germany's likely next chancellor, Merz, has seized the moment after the return of Donald Trump to the White House put the transatlantic alliance in turmoil and underlined the urgency for Europe to strengthen its own defense.

Economists and investors have urged Germany to reform its constitutionally enshrined state borrowing limits known as the "debt brake" in order to free up investment and support an economy that has contracted for the past two years.

The reform would mark a rollback of borrowing rules imposed after the 2008 global financial crisis that many have since criticized as outdated and putting Germany into a fiscal straitjacket.

"In view of the threats to our freedom and peace on our continent, whatever it takes must now also apply to our defense," said Merz, leader of the CDU/CSU conservatives.

"We are counting on the United States of America to continue to stand by our mutual alliance obligations in the future. But we also know that the resources for our national and alliance defense must now be significantly expanded."

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Euro rallies to 3-month high

The euro rallied to a three-month high on the news, German government bond futures fell sharply, while stock futures rose. European defense company shares have soared in recent days as momentum to ramp up spending across the region gathers pace.

Merz said the CDU/CSU and SPD parliamentary group would submit a motion to the Bundestag lower house of parliament next week to amend the constitution so defense expenditure above 1% of economic output is exempt from the debt brake.

A commission of experts will separately develop a proposal for modernizing the debt brake to boost investments on a permanent basis.

Changing the so-called debt brake and creating a special fund require a two-thirds majority.

The conservatives and SPD are rushing to get the moves passed in the outgoing parliament, given far-right and far-left parties will have a blocking minority in the new parliament after scoring strongly in last month's election.

The Greens party, whose support is needed to get the debt brake reform across the line, said it would look at the proposals but made no firm commitment.

Ukraine aid

Merz said he would meet outgoing SPD Chancellor Olaf Scholz on Wednesday to discuss additional aid for Ukraine, with more than 3 billion euros on the table.

"Our country is running on wear and tear, and that is why it was important for us to invest, to invest massively, so that our country functions better again. A future government must stop the deterioration of our country," SPD leader Lars Klingbeil said.

The United States has repeatedly pressured Germany to increase its defense spending to overhaul a military that has felt neglected since the end of the Cold War and diverted weapons to support Ukraine in the war against Russia.