The German Parliament approves the 2027 budget, with borrowing exceeding $222 billion

The Budget Committee of the German Parliament approved the draft budget for 2027, including new borrowing exceeding 210 billion euros ($222 billion), the second highest level of borrowing since World War II, according to people familiar with the file, on Friday.

The committee approved the budget package, which includes spending worth 561 billion euros, in the early hours of Friday morning, after weeks of negotiations that saw plans to impose taxes on plastics and sweetened beverages abandoned or postponed, in addition to reversing some cuts in spending on social security, with the aim of reaching an agreement, according to Reuters.

The ruling coalition led by Chancellor Friedrich Merz pledged to intensify investments in Germany's basic infrastructure and rebuild its military capabilities, after decades of lack of investment. Last year, it also agreed to ease restrictions on borrowing to finance defense spending.

However, the coalition faced difficulties in reconciling the priorities of its two partners, the conservative Christian Democratic Party and the center-left Social Democratic Party, which formed the ruling coalition following last year's elections.

After the approval of the Budget Committee, the draft budget became ready to be presented to Parliament for approval. However, the opposition parties accused the government of resorting to “open tricks” to hide the amount of borrowing and spending allocated for basic aid.

Sebastian Schäfer, spokesman for the opposition Green Party on budget affairs, said in a statement: “This is not sound fiscal policy, but rather a broad attempt to mislead and obscure the facts.”

The figures showed that total new borrowing amounted to 210.4 billion euros, a level slightly below the record recorded in 2021 during the “Covid-19” pandemic, amounting to 215.4 billion euros.

This amount includes new borrowing of about 123 billion euros from the basic budget, which does not include additional borrowing allowed under special financing mechanisms approved last year to allow greater spending on infrastructure and defense.

As part of the understandings that paved the way for approving the budget, officials in the ruling coalition agreed, late on Wednesday, to cancel a proposed tax on plastic packaging materials, which the government had approved in July, and to postpone the imposition of a tax on sugar-sweetened beverages until 2028. It was also decided to postpone the reduction of the electricity tax, of which Meretz was one of the most prominent supporters.

The two partners also agreed to withdraw plans to reduce aid provided to children from low-income families.

Two-year German government bond yields, the most affected by monetary policy expectations, headed towards recording their largest weekly rise in two months, with traders increasing their bets on raising interest rates by the European Central Bank, following the release of higher-than-expected US inflation data, at a time when the recovery in stock markets limited demand for safe assets.

German 10-year bond yields, which represent the euro zone's benchmark, rose by 3.5 basis points to 3.36 percent, on track to record a weekly increase of 11 basis points. These returns fell to 3.2075 percent last Friday, which is their lowest level since August 26, according to Reuters.

This came after the sharp decline in technology stocks last week prompted investors to increase their holdings of bonds, as they are considered a safe haven. In contrast, global stocks gave up early gains to trade lower on Friday.

In the short-term bond market, German two-year bond yields, which are more sensitive to interest rate expectations, rose by 1.5 basis points to 3.14 percent, recording an expected weekly increase of about 16.5 basis points.

Futures contracts linked to the euro short-term interest rate (ESTR) showed that traders expect the European Central Bank's deposit rate to rise to 3.25 percent by late 2027, compared to the current level of 2.50 percent, versus expectations of 3 percent, late last week.

The contracts also indicated that the interest rate would reach 2.74 percent by next December.

In the French bond market, the difference in yields between French government bonds and German bonds, which are considered a safe haven, trended towards recording its third weekly decline in a row. This difference reflects the premium that investors demand for holding French debt compared to German bonds.

The spread reached 144 basis points, heading down by 8 basis points during the week. It had recorded 177.72 basis points on October 22, its highest level since mid-November 2011, during the height of the sovereign debt crisis in the euro zone.

French bonds are still vulnerable to market pressure ahead of the presidential elections scheduled for next year, in light of continued investor concerns about the country's financial path.

New York Federal Reserve Bank President John Williams said that it is likely that there will be a need for further increases in interest rates, as part of the US central bank’s efforts to reduce high inflation, despite the continued strength of the US economy.

Williams did not specify the date of the next increase in interest rates or the size of the increases that the central bank might approve.

“The economy is strong, and the job market continues to improve, but inflation continues,” Williams said, during a UC Berkeley Alumni Association event held in New York.

He added: “We will need to take action over time to ensure that inflation returns to our 2 percent target in a timely and sustainable manner,” noting that the central bank “still has work to do to bring monetary policy to the appropriate level.”

Financial markets widely expect that the Federal Reserve will raise the key interest rate range, currently set between 3.75 and 4 percent, by a quarter of a percentage point during the next meeting of the Federal Open Market Committee in early December, and to raise it again in January, according to Reuters.

In the wake of higher-than-expected inflation data this week, discussion is escalating about the possibility of the Federal Reserve resorting to monetary tightening at a greater pace.

Core inflation recorded an increase of 0.3 percent during October, a pace that Federal Reserve Board member Christopher Waller had previously said might make raising interest rates by 50 basis points an option in December.

But other central bank officials, including Cleveland Fed President Beth Hammack, called for a more moderate and gradual approach to raising rates, to allow the economy room to adjust to higher short-term borrowing costs.

In response to a question about the rise in the cost of living as a result of the wave of inflation witnessed in the past five years, Williams said that the ability of the central bank to address this problem is limited.

He explained that the central bank uses interest rates to influence the rate of price change, not their absolute level, which means that the wave of inflation in recent years has left many individuals and companies facing much higher price levels.

He added that history shows that trying to restore prices to their previous levels is like “putting the genie back in the bottle,” which would lead to major imbalances and damage to the economy.

Williams pointed out that central banks decided over the past decades to focus on keeping inflation low, rather than trying to reverse the effects of wars or epidemics, and instead work to move forward.

He said that this approach has consequences, namely the continued rise in the cost of living.