NATO Agrees to Boost Defense Spending to 5% of GDP by 2035

Economic data, which had previously been reassuring, is now showing signs of an artificial boost due to tariff front-running. This phenomenon suggests that the underlying economic conditions might be less robust than initially indicated. The artificial bounce in economic data could be attributed to businesses and consumers accelerating their activities in anticipation of tariff increases, leading to a temporary surge in economic indicators.

This dynamic has led to a significant reversal in GDP nowcasts, as companies front-run their imports before tariffs were implemented, resulting in a mechanical bounce in growth. However, early signs indicate that this mechanical bounce is beginning to reverse, with leading labor indicators continuing to rise and the housing market showing signs of deterioration.

With the Federal Open Market Committee (FOMC) committed to delaying rate cuts as long as possible, the risks are building up. The recent economic data, which had been reassuring, may now be showing signs of an artificial boost due to tariff front-running. This phenomenon suggests that the underlying economic conditions might be less robust than initially indicated.

The NATO Summit held this week produced an agreement that aims to increase defense spending to 5% of GDP by 2035, with 3.5% allocated to "pure" military spending. This ambitious goal is driven by both diplomatic and military imperatives, particularly to satisfy the demands of the United States. The increased spending is intended to reinforce collective security in the face of growing threats, notably from Russia. However, the feasibility of this target remains uncertain, as many European countries are already struggling to meet the previous 2% threshold.

Germany, for instance, has a clear plan to reach 3.5% military spending by 2029, but other countries like France, Italy, Spain, and Belgium are lagging behind. Spain has even obtained an exception clause, allowing it to cap its spending at 2.1%. Italy's Defense Minister has publicly acknowledged the difficulty of reaching 3.5% without a concrete budget plan. The new threshold includes 1.5% for "defense-related expenditure," which allows countries to recycle some existing spending and show progress without significantly increasing their actual effort. This creative accounting could result in strict defense spending being as low as 1.2% or 1.3% for some allies, despite the need to meet 3.5%.

Despite the doubts about reaching the 5% mark, European defense spending is set to grow. By 2024, the Eurozone was devoting an average of 1.8% of GDP to defense, a figure that is forecasted to rise to 2.5% by 2026. Historically lagging countries such as Spain, Italy, and Belgium are catching up. Germany is already planning debt-financed increases in military spending, which has led to a significant increase in public debt issuance and visible effects on German long-term interest rates.

However, this increase in military budgets could be costly, both financially and politically. A rise to 3.5% of GDP financed solely by debt could increase the debt/GDP ratio by more than 10 points in several countries, notably France, Belgium, and Italy. These countries are already fiscally fragile, with virtually non-existent fiscal margins. Increasing military spending without touching other items would imply cuts in social welfare, pensions, and public services, an explosive scenario in electoral terms.

For countries close to Russia, such as Poland and the Baltic States, the debate is less sensitive, as their public opinion supports budget increases. But for Western Europe, the real question remains the "how": how to rearm without further weakening public finances under strain. And how to do so without stirring up the populism already lurking in ambush. By focusing on flexible objectives, the NATO Summit has found a political compromise that is effective in the short term. In the long term, however, military effectiveness will depend less on the magic of numbers than on the coordination of resources: pooling purchases, supporting the defense industry, and defining common priorities.

The NATO Summit marked a political turning point, with the 5% target serving as a signal to Washington and Moscow that Europe is taking its security seriously. However, to avoid this commitment becoming a mirage, governments will have to combine strategic ambition with budgetary rigor. Beyond the symbolism, Europe's military credibility is at stake.