Weekly Update - Germany: growth remains sluggish despite fiscal support on the horizon

The German government has announced its draft budget for 2027. It provides for an acceleration and strengthening of the investments already announced in 2025, particularly in infrastructure and rearmament. It comes at a time when economic activity has remained weakened for several years. And although the spending measures decided upon will mechanically support activity over the coming quarters, it is not yet clear whether they will be sufficient to enable a more durable rebound in potential growth.

Growth remains sluggish. The Merz government had announced a vast public investment program in infrastructure and defense, spread over ten years and whose rollout was due to begin at the start of 2026. However, at this stage, while public spending has indeed increased, mainly driven by higher transfers and public consumption, public investment remains limited. Growth in Q1 2026 was supported by this spending, but data for April and May already point to a slowdown in activity. Activity continues to be weighed down both by the energy crisis and by the still overly gradual ramp-up of public investment. At the same time, business investment continues to contract and is expected to remain weak in the coming months, in an environment marked by persistent tensions in global trade. It is in this context that the German government is now seeking to accelerate the pace of public spending.

Toward an acceleration of reforms. At the beginning of July, the Merz government presented its draft budget for 2027. Most of the proposed measures are a continuation of the reforms announced in 2025. The plan notably includes labor market reforms, with tax incentives encouraging worker mobility, measures simplifying taxation and certain regulations, as well as targeted support schemes for specific sectors. At the same time, this budget aims to speed up the procedures for selecting, approving, and disbursing funds intended for investment projects as well as defense spending.

An environment calling for a transformation of the growth model. Beyond the expected short-term support effect of this fiscal stimulus, the emphasis placed on investment and structural reforms addresses a deeper issue: adapting the German growth model to a permanently transformed economic environment. The model that long represented the country's strength, based on a competitive export-oriented industry and openness to trade, is now facing growing challenges. The return of protectionist policies in the United States, combined with the upgrading and increasing competitiveness of Chinese industry, is placing particular pressure on German manufacturing and exports. In this context, investments in strategic sectors, together with the reforms being implemented, aim not only to support activity in the short term, but also to strengthen the German economy’s ability to adapt to this new environment and restore its growth potential over the longer term.
 

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