European defence spending will increase materially in coming years. A credible sovereign defence capability may require the EU to raise defence spending from just under 2% of GDP to around 3.5% in the near term, and higher still over the medium term.

Key capabilities Europe needs to acquire include a major expansion of artillery production, as well as the creation of independent air defence and military intelligence capabilities. For now, a new nuclear capability under joint European command is unlikely. 

The European Commission is proposing mobilising €800 billion to finance this. Most would come from national borrowing facilitated by relaxed fiscal rules, alongside €150 billion of European-wide borrowing. 

But the actual increase in spending will depend on how different countries plan to make use of the new fiscal space. This is likely to vary based on existing debt levels, borrowing costs, and proximity to Russia. 

While the EU aims to develop sovereign capabilities in producing defence equipment, the need to rapidly rearm means that overseas suppliers will still be required. Alongside the US, countries that might benefit from this trend include Israel, South Korea, and the UK.

The growth multiplier on defence spending is typically quite low, especially with the economy close to full employment. All told, we are incorporating a fiscal defence injection of 3.3% of GDP into our forecasts, lifting the level of Eurozone GDP by 1.5% over the next five years, with some modest upward pressure on interest rates.

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