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UPDATE 1-Finmin undercuts German target of spending 1.5 pct of GDP on defence - source

(Adds details about potential programme cuts)

BERLIN, Feb 28 (Reuters) - Finance Minister Olaf Scholz’s budget plan calls for German defence spending of 1.23 percent of economic output in 2023, undercutting Berlin’s pledge to spend 1.5 percent of GDP on the military by 2024, a conservative source said on Thursday.

Scholz, a Social Democrat, wants to increase the budget for Germany’s military by 3.3 billion euros ($3.77 billion) by 2023 - much less than the 28.2 billion euro increase demanded by Defence Minister Ursula von der Leyen, the source said.

Chancellor Angela Merkel’s loveless coalition will thrash out a final budget plan by March 20, but is likely to miss its own scaled-backed target of spending 1.5 percent of GDP on defence by 2024, barring a last-minute cash injection, said the source, speaking on condition of anonymity.

That puts it even further away from meeting a pledge by NATO members in 2014 to move toward spending 2 pct of GDP on defence.

U.S. Ambassador Richard Grenell, who has repeatedly criticised Germany’s failure to boost military spending, urged Berlin to stick to its commitments.

“No members of NATO should be undermining NATO by not abiding by the alliance’s rules,” he said.”At a time of increased Russian aggression in Europe, Germany should support NATO fully.”

Scholz has vowed to keep a tight rein on fiscal spending given signs of slowing growth, although he has backed some proposals by his left-leaning party to boost social spending.

Von der Leyen, from Merkel’s centre-right Christian Democratic Union (CDU), is seeking extra funds to cover shortfalls in equipment and personnel that continue to plague the German military.

If Scholz prevails, the defence ministry would have to scrap two major procurement programmes, said the source from Merkel’s conservative bloc.

That could affect a joint submarine to be developed with Norway that involves Germany’s Thyssenkrupp and Norway’s Kongsberg; development of a new multi-role MKS 180 warship; a new missile defence system to be built by Lockheed Martin and European missile maker MBDA; or plans to buy a new heavy-lift helicopter.

The helicopter programme moved forward on Thursday with a pre-solicitation notice, with the ministry saying it now expects to issue a formal request for proposals in the second half of 2019. The ministry has previously said it expects to choose either of two U.S. helicopter models, the CH-47 built by Boeing or the CH-53K built by Lockheed.

$1 = 0.8760 euros Reporting by Sabine Siebold Writing by Michelle Martin and Andrea Shalal Editing by Riham Alkousaa and Gareth Jones