Europe faces huge costs to defend Ukraine

European defense stocks surged on March 3 after European leaders vowed to “take the burden” of defending Ukraine, according to the New York Times. The move comes as the three-year conflict between Ukraine and Russia appears to be entering a new phase following a tense Oval Office meeting on February 28.

Shares in major European defense companies — including British defense contractor BAE Systems, German arms maker Rheinmetall and Italian aerospace and defense company Leonardo — hit record highs on March 3. The sector’s surge helped lift the Stoxx Europe 600, an index dominated by luxury stocks, to new heights.

But behind the investor enthusiasm lies the question: Can Europe — faced with a high debt burden, persistently low growth, plus new tariffs from the US — afford to spend more on its military?

Ending the Russia-Ukraine conflict will come at a huge cost. British Prime Minister Keir Starmer laid out a four-point plan over the weekend at a meeting of European leaders with President Zelensky.

Mr Starmer's proposal includes a "coalition of the willing", led by Britain and France, to protect any deal that might be struck with Ukraine, which could mean "more ground and air forces". Britain has also lent Ukraine £2.26bn ($2.86bn) to help bolster its military.

But credit agencies have been warning about Europe’s fiscal health even before the summit. Fitch Ratings, for example, warned that increasing NATO members’ military spending to 3% of GDP—still below the 5% that Mr Trump wants—could force European governments to cut spending, unpopularity and weaken the social safety net.

Other political options include loosening fiscal rules to allow more defense spending, redirecting unspent pandemic recovery funds to bolster the military, and raising taxes.

Borrowing will also come at a high cost. European bond yields rose slightly on March 3, a sign that investors are worried about the possibility of increased public spending at a time when the region’s economy is slowing and competitiveness is weakening. Analysts are divided on whether such commitments could derail the European Central Bank’s plans to cut interest rates, which it meets later this week.

The stakes are high, too. Failure to help Ukraine could ultimately force European nations to accept a deal that is bad for Kiev and Europe. That could test the bloc’s cohesion, analysts say.