German fiscal plan: is investors’ impatience justified? - 26 May 2026

Hailed in 2025, the German mega budget plan is now testing investors’ patience. Although it cannot offset all the challenges facing the German economy, it is being rolled out gradually and is supporting growth.

After raising high expectations last year, the German budget plan of €1,000 billion in spending over 12 years failed to prevent the sharp downturn in business sentiment caused by the energy shock stemming from the war in Iran. The German PMI indeed fell back below the 50 threshold in April and May (Chart 1). This performance is only marginally better than that of the rest of the euro area, and remains well below those of the United States and Japan.

One might conclude from this German vulnerability that its fiscal policy is, in practice, still not genuinely expansionary. It is, however, worth recalling that the plan announced in March 2025 takes the form of an investment programme spread over a decade, rather than a large and rapid tax cut or a substantial increase in public consumption expenditure. The implementation of this plan therefore takes time, all the more so as it is hampered by regulatory obstacles and administrative inertia. Recently adopted laws should help to reduce these constraints.

It is also important to recall that, excluding military expenditure and off budget funds dedicated to ‘infrastructure and climate’, the constitutional balanced budget rule continues to apply. This compels the German government to implement savings plans.

Overall, however, public spending is rising significantly – the increase is expected to reach +8% in 2026 – and the budget deficit is widening as planned. The latest budget figures for April confirm these forecasts. Germany has certainly not yet spent the entire envelope allocated to military and civil expenditure, but the underlying momentum is clearly there. This is confirmed unambiguously by German industrial order statistics since last autumn (Chart 2).

German industrial growth nonetheless remains constrained by the ongoing crisis in two traditional sectors, the automotive and chemical industries, which have been hit hard by Chinese competition and by higher energy prices since the war in Ukraine and then in Iran. One of the main objectives of German fiscal policy is precisely to gradually redirect German industry towards defence, aerospace, electronics and electrical equipment, among other sectors.

Beyond manufacturing, another crisis is severely limiting the short term benefits of the German plan: that of residential construction. After a boom decade in the 2010s, the sector has still not reached its low point (Chart 3). The IFO institute expects the downturn to continue in 2026, unlike in other countries where a rebound is already under way (Spain, France, United Kingdom). IFO forecasts a slow recovery only from 2027 onwards.

German potential growth, finally, has fallen sharply over the past decade. According to European Commission estimates, it now stands at around +0.4% per year, compared with +1.5% in 2016. The working age population is expected to decline, and underlying labour productivity is rising only slowly. With growth forecast at +0.6% this year – despite the Iranian shock weighing on consumption – and +0.9% next year, the German economy would therefore not be doing so badly (Chart 4).

If these forecasts materialise, the German recovery would nevertheless remain only mildly inflationary, or even disinflationary once the Iranian energy shock has been absorbed. Although annual economic growth is expected to be higher than its potential rate, the level of activity and employment would remain below potential because of the ground lost since 2023.

The unemployment rate as defined by the ILO is admittedly remarkably low, at around 4%, but the Commission expects it to rise in 2026 before easing slightly in 2027. It would, however, remain above the non inflationary unemployment rate calculated by the Commission. The marked slowdown in wages observed over the past year could therefore continue (Chart 5).

Surveys of German firms confirm this diagnosis of a less tight labour market, where recruitment difficulties have eased significantly in industry and services after nearly a decade of strain. The scope for non inflationary growth in Germany therefore remains substantial. This is an important point for the ECB which, in addition to the energy shock from Iran, is also monitoring wages very closely.

For investors, German momentum therefore suggests that, even if the fiscal plan only partially shields growth from shocks, it is broadly proceeding as planned. Companies in the sectors concerned – defence, infrastructure, energy transition, electronics, etc. – will continue to benefit from it. In the short term, however, the overall cyclical environment, in Germany and even more so in the rest of Europe, will continue to depend on how the Iranian crisis is resolved. Finally, it seems unlikely that, in the event of a positive resolution of the conflict in Iran, the expected recovery of the German economy would quickly turn into an inflationary boom.