Make Europe great again? Germany’s fiscal shift is redefining the European investment playbook

Key points

• Germany’s fiscal u-turn – After years of austerity, Germany is unleashing over €500 billion in industrial and energy investments, on top of planned spending increase on defense, signaling a major shift in European economic policy.

• Investment opportunities – Increased spending on defense, infrastructure, and green energy could boost industrial stocks, renewable energy firms, and European banks, while prolonged higher interest rates may reshape market dynamics.

• Risks and inflation pressures – While this spending spree could revitalize Europe, risks remain, including potential ECB tightening, bureaucratic delays, and political hurdles in sustaining high fiscal commitments.

For years, Europe has been synonymous with slow growth, fiscal austerity, and an overreliance on monetary policy to keep its economic engine running. But a major shift is now underway. Germany, long the poster child of fiscal discipline, is cracking open the purse strings, and the ripple effects could be huge.

The end of German austerity?

Germany has traditionally maintained one of the most conservative fiscal policies in the world, prioritizing balanced budgets and debt reduction. This approach, while keeping the country’s finances in check, often meant subdued public investment and limited government stimulus.

But times are changing. Berlin is now rolling out a more expansionary fiscal agenda, including increased spending on defense, infrastructure, and energy transition. The numbers are significant – Germany’s incoming Chancellor Friedrich Merz has already committed €500 billion of infrastructure fund to invest in transportation, energy grids and housing over the next 10 years. This is in addition to a €150 billion spending on defense modernization after the US threatening to pare back its security presence in Europe.

For context, this combined spending is more than 3x what Germany allocated for its entire post-pandemic stimulus package. A more aggressive fiscal stance by Europe’s largest economy signals a shift in the region’s overall approach to economic management, which could unlock new investment opportunities.

Germany is also calling for other EU nations to reform their fiscal rules to allow bigger defense spending with the geopolitical circumstances. Seven EU member states, including major economies Italy and Spain, are below Nato’s defence spending benchmark of 2% of GDP. Just four – Poland, Estonia, Latvia and Greece – spend more than 3%.

A more expansionary fiscal policy could reshape the European investment landscape. Here’s how:

1. Industrial renaissance?

Europe’s industrial base has been struggling, with high energy costs and supply chain disruptions weighing on competitiveness. But with Germany leading the charge in energy investment, defense spending, and infrastructure, industrials and manufacturing stocks could see a boost.

For example, Siemens Energy and other industrial giants stand to benefit from the €28 billion earmarked for energy grid upgrades alone. Meanwhile, aerospace and defense companies like Rheinmetall could see a surge in contracts as Germany bolsters its military.

2. Inflation and the ECB’s dilemma

More government spending typically fuels inflation, which could keep pressure on the European Central Bank (ECB) to maintain higher interest rates. If inflationary forces persist, investors may need to adjust their expectations for rate cuts and position portfolios accordingly, favoring value stocks over growth names and sectors that can pass on higher costs to consumers.

With eurozone inflation still hovering around 2.5%, and Germany’s own inflation around 2.8%, this fiscal push could keep borrowing costs elevated for longer than expected.

3. The Euro’s comeback?

A stronger fiscal commitment from Germany and other European nations could bolster investor confidence in the region’s economic prospects. If this translates into higher growth expectations, the euro could gain strength against the U.S. dollar, impacting currency-sensitive investments and trade balances.

Some analysts predict that stronger European fiscal policies could push the euro back towards $1.15-$1.20 against the dollar, up from the current level of $1.08.

4. More capital moving to Europe

For years, global investors have prioritized the U.S. over Europe due to better growth prospects and a more dynamic tech sector. But if Europe’s fiscal shift creates stronger domestic demand and investment opportunities, capital flows could begin tilting back toward European equities.

The EU's recovery fund, alongside Germany’s fiscal push, represents a €750 billion commitment to revamping European industries. If even a fraction of this results in higher corporate earnings, Europe’s stock market – currently still trading at a discount to U.S. equities despite the YTD outperformance – could see a rerating.

How to position for the shift

For investors, this new era in Europe means thinking differently about allocations. Some key ideas:

• Industrials and infrastructure players like Siemens and Bilfinger could benefit from increased public investment. This could also benefit Materials sector with key players such as Heidelberg and BASF likely to see increased demand.

• European defense stocks such as Rheinmetall, Thales, and BAE Systems are likely to see tailwinds from higher military spending.

• Renewable energy and green tech companies in Europe such as Vestas Wind or power generators like Orsted and Iberdrola could thrive as Germany accelerates its transition away from fossil fuels, but higher yields could weigh on utilities.

• The banking sector (Deutsche Bank, Commerzbank, BNP Paribas) might gain from prolonged higher interest rates if inflation persists.

Reality check: The risks still exist

While this fiscal expansion is a major shift, it doesn’t come without risks.

• Budget constraints: Germany still adheres to a constitutional “debt brake,” which limits how much it can borrow. If economic conditions worsen, funding these initiatives could become politically contentious.

• Execution challenges: Large-scale public investments often face bureaucratic delays, meaning the impact could take longer to materialize than markets anticipate.

• ECB response: If inflation rises too much, the ECB could tighten policy further, offsetting some of the benefits of fiscal expansion.

Bottom line

Germany’s fiscal pivot isn’t just a local policy shift – it’s a game-changer for Europe’s economic trajectory. Investors who recognize this shift early can tap into opportunities that were previously limited by the region’s cautious fiscal stance. While risks remain, the numbers are big, and the impact is likely to be real. The European investment playbook is being rewritten.