The Frankfurt DAX soared more than 3.5 percent in late morning deals, erasing the previous day's losses, which were sparked by fears that Europe would be the next target of US President Donald Trump's tariffs war.

The yield on 10-year bonds rose 23 basis points 2.73 percent, the biggest jump since June 2022 -- making borrowing costs higher.

Merz said Tuesday that his centre-right CDU/CSU alliance and the centre-left Social Democrats would propose an unprecedented spending package.

The parties, which are in talks on forming a coalition, plan to create a special 500 billion euro ($535 billion) fund for infrastructure and defence investment.

The fund would be aimed at kick-starting Germany's moribund economy, which is threatened with a third straight year of recession.

Merz's plan would also exempt defence spending from Germany's constitutionally enshrined "debt brake" when it exceeds one percent of gross domestic product.

"This is huge," said Kathleen Brooks, research director at XTB trading platform.

"For years, economists have said that Germany needed to change its spending rules to get out of the economic hole. It's taken a Conservative Chancellor-in-waiting to pull the trigger," she said in a note.

The proposal suggests that Berlin will borrow massively in the future, a move that can send government borrowing costs higher as investors demand bigger returns to buy bonds.

German government bond yields nevertheless remain the lowest in the eurozone thanks to years of budgetary discipline.