Germany's government-in-waiting has agreed €14 billion in budget savings next year and €35 billion in 2007 to meet euro-zone deficit guidelines, but has yet to agree on how to raise taxes and cut spending.
The plan, amounting to 15 per cent of the German federal budget and called the greatest budget consolidation in postwar German history, is a vital step in forming a grand coalition between Christian Democrats (CDU) and Social Democrats (SPD).
The announcement comes as German business confidence made an unexpected jump to a five-year high in October, according to the closely-watched Ifo survey.
"If we want to adhere to the Maastricht criteria - and that's what we want - we'll have a consolidation requirement of €35 billion over the next 14 months," said Dr Angela Merkel, CDU leader and chancellor-designate.
SPD leader Franz Müntefering said: "It's clear that milk and honey won't flow." Departing chancellor Gerhard Schröder said he was "convinced that it will all go well" and that a "good government" will be in place by mid-November.
However, Dr Merkel was cautious about the breakthrough, saying that the new government had a "difficult inheritance" from the Schröder era and warned that the grand coalition was "not yet wrapped up". The real challenge comes next week, when savings proposals are hammered out and presented to the two parties.
Proposals expected to be discussed in detail next week include one-off privatisations worth around €15 billion and increasing 16 per cent VAT in two stages to 18 and then 20 per cent, raising around €30 billion annually. Germany's finances are the most urgent problem facing the new government, with average growth of just 1.2 per cent over the past seven years, over 10 per cent unemployment and a federal deficit of €1.5 trillion.
New borrowing this year is likely to reach €34 billion, breaching for the fourth time in succession the euro-zone ceiling for new borrowing of three per cent of gross domestic product (GDP).
EU officials have warned that Berlin will face a multi-billion-euro fine unless it takes drastic steps to reign in its deficit spending by 2007.
Strong exports and hopes of a global upswing pushed the Ifo index to 98.7 points in October, compared to 96 points in September.
"The economic recovery seems to be on firmer ground," said Mr Hans-Werner Sinn, president of the Ifo.
Germany's Chambers of Industry and Commerce (DIHK) released a report last week, showing similar rises in investor confidence.
