Germany eyes swift moves on defence, investors sniff bonanza

By Andreas Rinke and Christian Kraemer

The prospect of a military spending boom by Germany unprecedented since the Cold War sent Europe's defence stocks soaring after Reuters reported the likely next government was mulling a fiscal sea change for Europe's biggest economy.

Germany's likely next chancellor, Friedrich Merz, did not confirm that his conservatives and the Social Democrats were considering setting up special funds worth nearly a trillion euros to finance urgent defence and infrastructure spending.

But he said spending decisions had to be taken "with great urgency" after U.S. President Donald Trump and his deputy harangued Ukrainian President Volodymyr Zelenskiy in the Oval Office on Friday, crystalising European fears about what some leaders view as Washington's biggest policy reversal since World War Two.

"We must now show that we are in a position to act independently in Europe," he said, adding that he hoped the parties could reach an agreement before Thursday's European defence summit.

News of the proposed funds prompted double-digit percentage rises in shares in defence contractors - including Thyssenkrupp, Hensoldt, Renk, Rheinmetall, BAE Systems and Leonardo - on Monday morning.

Sources told Reuters on Sunday that the parties were considering special funds for defence and infrastructure, and that economists had proposed to them that these be worth 400 billion euros ($417 billion) and 500 billion euros in size respectively. These sums combined would amount to 20% of German GDP.

"There is an enormous need for investment and we won't create consent for it if we just invest in defence," SPD General Secretary Matthias Miersch said on Monday. "The two need to be considered together."

If confirmed, it would amount to an extra 2% of economic output in spending over the next 10 years, kicking in from next year.

"This would be about as much as the country has invested in East Germany since reunification," three decades ago, Deutsche Bank wrote. "It would be a fiscal regime shift of historic proportions."

Bild newspaper reported that an extraordinary session of parliament might be called for next Monday, which would allow the measure to be passed with the backing of the Greens - who on Monday urged Chancellor Olaf Scholz's outgoing government to approve a further 3 billion euros' funding for Ukraine.

UNJAMMING THE BRAKE?

After the new parliament is seated this month, the defence-sceptical Left party's support will be needed to reach the necessary two-thirds majority if all parties stick with their commitment not to work with the second-placed, far-right, Kremlin-friendly Alternative for Germany (AfD).

For decades, Germany has been a defence laggard, until 2023 spending less than NATO's target of 2% of economic output on defence, with Russia's invasion of Ukraine and Scholz's defence "Zeitenwende" or sea change only bringing modest changes.

The soaring shares highlight investor confidence that the makers of military vehicles, ammunition and other battlefield kit will be big winners from the bonanza.

Scholz's previous attempts to boost military spending also relied on a special fund, formally separate from Germany's 2 trillion euros in public spending.

There are 29 of the funds, which have been part of Germany's budget landscape since 1949, but they have mushroomed since Scholz's government was forced to seek creative ways to expand military spending without violating a constitutional spending cap that limits how much debt governments can take on each year.

They are legally tricky: a court ruling against his use of another fund paved the way for the collapse of his government and the election he lost last month, while the state auditor has called for their use to be reined in.

Originally state-sponsored credit lines, the funds have increasingly had the power to borrow against their own assets.

The economic impact of the defence fund would be modest in the short term, Deutsche Bank wrote, since much of it would be spent on imports.

The infrastructure fund, badly needed after years of frugality have left much of Germany's public realm, from bridges to railways, in a ragged state, would have a bigger impact.