Germany’s parliament has passed a historic spending bill enabling the government to finance hundreds of billions of euros in defence and infrastructure.

The passage marks a major fiscal shift for a country long constrained by spending austerity under the so-called ‘debt brake’ introduced in 2009.

While investors remain broadly optimistic about the landmark spending package, the reform has wider implications for Germany’s equity markets and government bonds.

The spending bill, championed by Germany’s conservative CDU/CSU leader and Chancellor-in-waiting Friedrich Merz, will allow defence spending to exceed 1% of Gross Domestic Product (GDP), amounting to approximately €45bn, with no upper limit.

Additionally, the plan includes a €500bn special fund for infrastructure investment over the next twelve years, with €300bn allocated to the federal government, €100bn to state governments, and €100bn to the Climate Transition Fund. The bill will also raise the borrowing limit for state governments from 0% to 0.35% of GDP.

The lower house of parliament, the Bundestag, passed the bill with 513 votes in favour and 207 against, comfortably exceeding the two-thirds majority required to amend the constitution. However, the legislation still requires approval from the Bundesrat, which represents Germany’s 16 federal states, in a vote scheduled for Friday. Merz faces urgency in securing the legal change before a new parliament is formed next week, as opposition parties could seek to overturn the decision.

How investors see the landmark spending package

Germany’s benchmark DAX index extended a three-day winning streak, rising 0.98% on Tuesday and briefly reaching a record high. Cyclical stocks, including Rheinmetall, Bayer, Continental, and ThyssenKrupp, surged between 4% and 10% before pulling back.

“Implemented in the right way, investment in infrastructure should lead to at least a cyclical upswing,” wrote Carsten Brzeski, global head of macro at ING, in a report on Tuesday.

“The chances of a cyclical rebound in the German economy on the back of positive sentiment effects and later actual spending have clearly increased.”

However, he also cautioned that the spending package would “do very little to improve the economy’s competitiveness” due to persistent structural challenges.

The landmark fiscal reform is expected to reinvigorate Germany’s economy, which has contracted for two consecutive years amid surging energy-driven inflation, weak government spending, and high interest rates. The country has faced mounting pressure to relax its borrowing constraints, which currently cap the government’s deficit at 0.35% of GDP.

However, volatility may persist in Germany’s bond market due to concerns over rising fiscal deficits. Bond yields—representing government borrowing costs—saw their largest weekly increase since the 1990s at the start of March, as investors demanded higher risk premiums in anticipation of an unprecedented surge in public debt.

“We anticipate that European bond markets will remain volatile as they digest the implications of such a significant increase in government debt entering the market, as well as the potential for higher borrowing costs in the long term,” wrote Roger Hallam, global head of rates, and Shaan Raithatha, senior economist at Vanguard, in a report last Friday.

“The 4 March announcement only strengthened our conviction in our view of German bund underperformance,” they added, referring to Merz’s spending plan.

Germany’s 10-year bund yield was little changed at 2.81% on Tuesday, as markets had largely priced in the bill’s approval. However, yields remain at their highest level in nearly 18 months, reflecting ongoing concerns about the country’s fiscal outlook.