LIVE MARKETS-German debt brake: don't forget the escape clause

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GERMAN DEBT BRAKE: DON'T FORGET THE ESCAPE CLAUSE

Whether a new German government will reform the debt brake and increase military spending is the hot topic ahead of German elections this weekend.

The key risk to a reform of the debt brake comes from whether smaller parties polling around the 5% threshold make it to the Parliament (FDP, BSW, and the left), Citi analysts argue, flagging that it's not their base case scenario.

FDP is against the debt brake reform and, together with AfD, could form a blocking minority, while negotiations might be tricky with the left, which doesn't want more defence spending.

A two-thirds majority is required to change the rule, which prevents governments from expanding the fiscal deficit, and a blocking alliance of the AfD and BSW could make financing increased military spending all but impossible.

UBS economists say that to create significant fiscal space, Germany can trigger the escape clause, which states that the debt brake can be deactivated in cases of "exceptional emergency situations" outside the government's control and have significantly adverse effects on public finances.

The escape clause, triggered by a simple majority in Parliament, removes deficit limits, while the EU fiscal rules remain in place.

However, the European Commission will propose exempting defence from EU limits on government spending, the head of the EU executive, Ursula von der Leyen, said on Friday, amid pressure from U.S. President Donald Trump for Europe to finance its own defence.

Citi economists’ base case is for a CDU/CSU coalition with either SPD or greens, with a €100bn infra/defence fund for 3 years and by then debt brake reform to allow 1% of structural deficit/GDP ratio from 2028.

(Stefano Rebaudo)

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