Crédit Mutuel AM: Growth German economy will be, at best, marginally positive in 2025

17 februari 2025

By François Rimeu, Senior Strategist, Crédit Mutuel Asset Management

The German economy shrank for the second consecutive year in 2024, declining by -0.2%. Forecasts for 2025 continue to be revised downward across the board. The German central bank, the International Monetary Fund (IMF) and the Kiel Institute estimate that growth will be, at best, marginally positive in 2025.

In parallel, Germany has managed to maintain its government budget deficit under control, remaining below 3 % in 2022, 2023 and 2024, which is significantly lower than the deficit of France (between 5 % and 6 % over the same period), Italy (between 4 % and 8 %) and Spain (between 3 % and 4.5 %)^[1]. The weak growth and subsequent rising unemployment rate have sparked debates for several months about the “debt brake” rule. This rule, which has been enshrined in the constitution since 2009 following the financial crisis, limits the structural annual budget deficit to 0.35% of the Gross Domestic Product (GDP) and explains Germany’s small deficit. It is therefore no surprise that it has become a major issue in the upcoming elections on February 23 in Germany.

Recent polls^[2] predict a clear victory for right-wing sister parties, the Christian Democratic Union (CDU) and the Christian Social Union in Bavaria (CSU), with 29.8% of voting intentions. The far-right Alternative for Germany (AFD) continues to gain momentum with 21.5 % of voting intentions, while the Greens (die Grünen) and the Social Democratic Party of Germany (SPD, center) stand at 13.1 % and 16.1 %, respectively. Three other parties, the Free Democratic Party of Germany (FDP), the Sahra Wagenknecht Alliance (BSW, conservative far left) and Die Linke (far left) are hovering around the 5 % threshold, required for parliamentary representation. Converting polls into parliamentary seats is complex and uncertain, as the final results will largely depend on whether these three parties surpass the 5% mark.

It is possible that the CDU/CSU will only need one party (the Greens or the SPD) to secure a simple majority. However, our base scenario remains a “Grand Coalition” led by Friedrich Merz as Chancellor as opposed to a more fragile coalition with either the SPD or the Greens due to a smaller majority.

However, the most important issue is not whether the coalition will be built around two or three parties. What matters is whether those opposed to any reform of the “debt brake” rule will secure a blocking minority, meaning over 33% of the seats. Amending the constitution requires a two-thirds majority. The AFD is currently opposed, as are the BSW and Die Linke. Should these last two parties surpass the 5% threshold, it could make any change extremely difficult. Nevertheless, achieving a sufficiently broad consensus to allow for a modification in the constitutional rule is not unrealistic.

However, the three parties that are likely to form the coalition do not share the same position on a constitutional reform: The SPD and the Greens are more ambitious while the CDU/CSU is more cautious about making deep changes to the rule. The combined score of the Greens and the SPD will therefore determine their influence in negotiations with the CDU/CSU. The higher their score, the more ambitious the modifications to the “debt brake” rule could be. Indeed, Friedrich Merz has repeatedly stated that while he is not opposed to reforming the rule, new spending must be linked to investment.

However, given the proposals of each of these three parties, it is the CDU/CSU that seems to advocate for the most significant tax reforms:

The CDU/CSU seeks to cut the corporate tax rate to 25%, abolish the solidarity tax for wealthy households, reduce the income taxes and lower the VAT. Additionally, they aim to lower electricity prices, simplify the immigration process for skilled workers and restrict access to certain social benefits. The SPD, on the other hand, plans to reduce income taxes for lower-income households while increasing taxes for high-income brackets, with the goal to reduce inequalities. They also aim to raise inheritance taxes and introduce a wealth tax. Alternatively, they would like to lower VAT on food and reduce corporate taxes in the case of investment. As with the CDU/CSU, electricity prices would be reduced and access to the labor market would be simplified for skilled foreign workers.
The Greens offer proposals similar to those of the SPD, along with “climate” subsidies for households, excluding the wealthiest.

Military spending could be excluded from the debt calculation envelope in order to “simplify” the debate; however, an increase in these expenditures is likely to meet the demands of the Trump administration. The stance on nuclear energy may also change but would require both a change in legislation and significant technical controls. In fact, a small majority of the population now supports nuclear energy. (Source: Radiant Energy Group, 2024)

The Cologne Economic Research Institute estimated the fiscal impact of the various programmes at €70 billion for the CDU/CSU, €15 billion for the SPD and €32 billion for the Greens. As a result, it is difficult to connect these proposed spending increases with the parties’ positions on the debt brake rule, especially for the CDU/CSU. It will likely be difficult for Friedrich Merz to adopt a “spending” stance during the elections given his party has always been seen as the most fiscally virtuous one, but ultimately, he would not be opposed to amending the constitution.

We believe a constitutional reform is likely following the German elections, though this is not guaranteed if the “small” parties opposed to it exceed the 5% mark. Estimating the fiscal impact is a difficult exercise but will most likely be marginal in 2025. According to German constitutional law experts, any change to the constitution before September is, in fact, unrealistic.

What does this mean for financial markets?

The psychological impact of such a reform should not be underestimated. The prospect of lower electricity prices and tax cuts for both businesses and households is likely to positively influence consumption and investment. Recent indicators show a slight improvement with PMIs rising above 50 as of 31/01/2025, Source: S & P Global (this is also the case for Sentix indicators). Additionally, the ripple effect on other Eurozone countries should not be overlooked; for instance, we estimate that a 1% increase in GDP for Germany would lead to a 0.1% rise in GDP for France.

For financial markets, this would be positive news and could lead to inflows into the region, particularly towards equity markets. The CDU/CSU program seems to support sectors such as real estate/infrastructure (less rent control, chronic underinvestment that should ease), automobile (they are likely to be in favor of fewer CO2-constraints), defense (higher spending) and financials. Given that Germany’s forecasts are only slightly revised upward, the ECB's monetary policy should not be significantly impacted in 2025. Such a reform would also be positive for the Euro currency. Of course, the German elections are not the only factor influencing these markets.

Developments in the Trump administration's policies and any potential fiscal stimulus from China will be equally important.
 

_{[1] German growth 2024 & Budget deficit 2022, 2023, 2024, Source: Bloomberg
[2] Europeelects, as at 10/02/2025}