A planned uptick in defense and infrastructure spending in 2025 is expected to increase growth in Germany and spill over into other Eurozone economies, according to analysts at Goldman Sachs.
In a note to clients, the analysts said they now expect Europe’s largest economy to grow by 0.2% this year, up by 0.2 percentage points, citing the impact of "notably higher public spending financed by higher deficits."
The comments come after German parties currently in talks to form a coalition government agreed earlier this week on a deal to loosen the country’s strict borrowing limits.
The move to ease Germany’s so-called debt brake -- a key sticking point that partly led to the collapse of current Chancellor Olaf Scholz’s government late last year -- also came with a deal to create a new 500 billion-euro fund aimed at bolstering infrastructure and defense spending.
Friedrich Merz, the leader of Germany’s Christian Democratic Union and likely Scholz’s successor, is set to present a joint bill in the country’s outgoing parliament next week. The Goldman Sachs analysts led by Sven Jari Stehn predicted that that it will be approved by lawmakers before the new parliament convenes on March 25.
Merz said the agreement between the CDU, its Bavarian sister party and Scholz’s Social Democrats was in response to recently growing fears over Europe’s defense capabilities and signs of sluggishness in the German economy.
Adding that there could be "some spillovers" from the increased activity in Germany in neighboring countries, the Goldman analysts also lifted their growth outlook slightly for the rest of the Eurozone area in 2025.
"We assume that spillovers are larger for France, smaller for Spain, and average for Germany and Italy, to reflect the likely trade flows in defence spending," the analysts wrote. "Another reason is that we now expect the rest of the Euro area to step up military spending somewhat more quickly in response to the German announcement."
The brokerage raised its growth forecast for the currency bloc this year by 0.1 percentage point to 0.8%. However, they flagged continued "near-term downside risks" from the possibility of upcoming reciprocal U.S. tariffs on European Union goods.
Threats from President Donald Trump to upend Washington’s longtime trading partnership with the EU have weighed on the outlook for the region and clouded the path ahead for European Central Bank interest rates. The ECB is widely expected to slash rates by 25 basis points to 2.50% at its meeting on Thursday, but its plans for the rest of the year remain uncertain.
Fueled by signs of tepid Eurozone growth and cooling inflation, policymakers have rolled out a series of recent cuts. But the Goldman analysts argued that Germany’s spending proposal "lowers the pressure for the ECB to reduce rates" below the so-called neutral level that neither helps nor hinders economic activity.
"We therefore no longer expect the Governing Council to cut at the July meeting," the brokerage said, adding that it now projects the ECB’s benchmark rate will fall to 2% in June. It had earlier seen the rate dipping to 1.75% in July.
