The Future of European Defense: Rising Military Budgets, Investment Growth, and NATO’s Strategic Shift

With increasing geopolitical uncertainty, Europe is under growing pressure to boost defence spending to 3% of GDP, driving significant investment opportunities in the defence sector, while political, economic, and industrial constraints continue to shape the trajectory of military expenditure and self-sufficiency.

The evolving geopolitical landscape has placed European defense spending at the center of global discussions, with renewed pressure to increase military budgets. The latest policy directions from the U.S. administration suggest a shift in NATO’s financial burden toward Europe, raising questions about the feasibility of significantly increased defence expenditure.

A 5% Defense Spending Target: Is It Realistic?

The idea of European nations increasing defense spending to 5% of GDP has been introduced as a potential solution to decades of military underinvestment. Since the end of the Cold War, defense spending in Europe has lagged by an estimated $2 trillion, creating a significant gap in military capabilities and infrastructure. While there is an increasing push for Europe to reduce its reliance on U.S. military support, a jump to 5% of GDP in defence expenditure is widely considered unrealistic.

Three Key Challenges to Achieving 5%

1. Economic Constraints – With limited fiscal headroom, European nations would require an additional $600 billion annually to reach a 5% defense spending target. Given ongoing economic challenges, including inflation and budgetary pressures, such an increase is highly improbable in the near term.

2. Political Barriers – The prospect of reallocating government spending to defense budgets remains a contentious issue. Increasing military expenditure would necessitate significant cuts in other critical areas such as healthcare, infrastructure, and education, making it a difficult sell to voters and policymakers.

3. Industrial Readiness – Due to prolonged underinvestment, the European defense industry lacks the immediate capacity to absorb such a sharp rise in spending. Scaling up defense production and technological capabilities requires a long-term commitment that cannot be met with short-term spending increases.

Given these constraints, a more achievable goal appears to be a rise in defence budgets to 3% of GDP. This would represent a significant increase of approximately $200 billion annually, allowing European nations to match the projected U.S. defense spending level of 3.1% of GDP in 2024. This level of expenditure would also strengthen defence industry fundamentals, ensuring a more sustainable growth trajectory.

Europe’s Dependence on U.S. Defense Capabilities

Europe remains highly dependent on U.S. defence technology and arms imports. Between 2019 and 2023, over 50% of European arms imports came from the United States, up from 35% in 2014. The trend reflects not only Europe’s reliance on American military support but also the comparative advantages of U.S. defence technology.

Key Reasons for Europe’s Dependence on U.S. Defense Equipment

• Advanced U.S. Technologies – The United States has consistently invested in cutting-edge defense innovations, giving its military equipment a competitive edge.

• Economies of Scale – The U.S. defence industry benefits from large-scale production, making American military equipment more cost-effective.

• Strategic Partnerships – Decades of close military cooperation between Europe and the U.S. have fostered deep integration in defence supply chains.

However, if Europe is serious about reducing its reliance on U.S. military support, significant investments in domestic defense infrastructure will be required. Expanding technological capabilities and production capacity will be essential to establishing a self-sufficient European defense industry.

How Can Europe Fund Higher Defense Spending?

One of the biggest obstacles to increased defense spending is the lack of a clear, long-term financing strategy. Some temporary funding solutions have emerged, such as:

• • Special off-balance-sheet defence funds (e.g., Germany’s €100 billion defence fund).

• • Utilisation of interest from frozen Russian assets to finance military spending.

However, these measures are short-term solutions rather than structural changes. To sustain higher defense spending levels, Europe will require stronger political commitments and comprehensive long-term funding mechanisms.

Key Upcoming Political Events to Watch

1. German Elections – Policy changes in Germany, including potential modifications to the country’s constitutional debt brake, could unlock additional defence funding.

2. French Budgetary Process – France’s fiscal outlook and willingness to allocate more resources to defence spending will be crucial.

3. NATO Summit in June – A potential increase in the official NATO defense spending target to 3% could serve as a catalyst for structural changes in military expenditure policies across Europe.

Outlook for the European Defence Industry

Despite the challenges, the long-term outlook for the European defense industry remains highly positive. LupoToro Group Analysts have strengthened their bullish stance on the sector as part of their 2025 forecast. The increasing pressure to elevate military budgets—even to a more moderate 3% of GDP—will create long-term growth opportunities for European defense companies.

Key Investment Considerations

• Increased Military Budgets – Higher spending commitments will support revenue growth across the defense sector.

• Stronger Industry Fundamentals – With a higher baseline for defense spending, companies in the sector stand to benefit from sustained demand.

• Attractive Valuations – The sector is currently trading at levels in line with historical averages, despite the improving growth trajectory.

Potential Risks to the Industry Outlook

The key variable in determining the long-term outlook for European defense is the extent of political commitment to higher military budgets. While economic and industrial factors suggest an upward trend, uncertainty remains around political willpower and budget allocations.

Key risks include:

• Political delays in funding approvals – A lack of decisive action from European governments could slow the pace of investment.

• Resistance to reallocation of funds – Balancing defense spending with social welfare priorities may create tensions within governments.

• Geopolitical shifts – Changes in global security dynamics could alter defense spending priorities unexpectedly.

The European defence industry is entering a transformative phase, driven by increasing geopolitical uncertainty and shifting policy priorities. While a rapid jump to 5% of GDP in defence spending is highly unlikely, a gradual rise to 3% appears to be a more achievable and impactful target.

The success of Europe’s defence expansion will depend on a combination of political resolve, industrial capability growth, and long-term funding strategies. With elections, budgetary decisions, and NATO policy shifts on the horizon, 2025 is shaping up to be a pivotal year for the future of European defense.

LupoToro Group Analysts remain bullish on the sector’s long-term growth potential and anticipate stronger commitments to defense investment in the coming years.