Wages Frozen, Gas Doubled, Warships Wanted
On 1 October Prime Minister Sébastien Lecornu unveiled €54 billion of savings in France’s 2027 budget. They include a public-sector pay freeze and limits on pension increases, alongside a military budget still on course to double. The next day European gas closed at €76 a megawatt-hour, up 143% on a year earlier. Storage stood at 71% against a five-year average of 87%, and Germany’s at just 57%, because Qatar has extended its force majeure on LNG deliveries into December. In the same fortnight, Kaja Kallas, the EU’s foreign-policy chief, begged member states for more warships to protect shipping now that the Houthis hold the Bab al-Mandeb. In August a drone packed with explosives was found on the tarmac at Leipzig airport, apparently aimed at a Ukrainian cargo plane. Europe is not facing a security crisis and an economic one. It is facing one crisis with three fronts, and it is paying for all of them out of the same national budgets.
Three Shocks, One Bill
At NATO’s Hague summit in June 2025, European allies pledged to spend 5% of GDP on defence by 2035: 3.5% on core military spending and 1.5% on related security. Euro area defence spending was about 1.5% of GDP in 2025. Spain negotiated an exemption on the spot. The EU’s response was Readiness 2030, which aims to mobilise €800 billion, almost all of it through national borrowing permitted under a suspension of EU deficit rules. Only €150 billion comes as common loans through the SAFE instrument.
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Two further shocks then landed on that plan. The Iran war cut Gulf LNG, which supplies about a fifth of the world’s traded gas. The Houthi seizure of Yemen’s Red Sea coast put Europe’s shortest route to Asia under a hostile flag. Meanwhile the Ukraine war grinds on. This spring’s ceasefire attempts collapsed within hours, and Russia’s campaign of drone incursions and sabotage against NATO territory, from Polish airspace to German airports, has entered its third year.
A Common Threat on National Balance Sheets
The usual framing is guns versus butter: a temporary choice that will ease once the threats recede. Both halves are wrong. None of the three shocks is likely to revert soon, and Europe as a whole can afford the guns. The ECB estimates that the extra defence spending already planned will add 0.4 percentage points to euro area growth over 2025–28, with less than 0.1 points of extra inflation, because most of it is spent on equipment rather than salaries. At the continental level, the arithmetic works.
The trouble is where the money comes from. The ECB calculates that roughly 70% of the euro area’s extra defence spending comes from Germany alone. Berlin’s 2027 budget lifts core defence to €109 billion on the way to 3.5% of GDP by 2029, financed by borrowing €838 billion between 2027 and 2030. Germany can do that because its debt starts at about 66% of GDP. France starts at 119%, with a 5.4% deficit, which is why it must cut €54 billion to keep spending on defence. Italy’s debt is 135% of GDP and Greece’s 151%, according to an Intereconomics analysis, and both face some of the steepest climbs to the NATO target. Europe is buying a shared good, deterrence of Russia, with national balance sheets of very different strength.
In countries without room to borrow, the social model becomes the thing that gives. France is freezing public pay and limiting pension rises. Even Germany’s 2027 budget trims social benefits and pension subsidies. Voters have noticed the trade-off and dislike it. In polling compiled by the Centre for European Reform, 68% of French respondents backed higher defence spending, but 50% opposed cutting public services to pay for it. In Britain, 57% opposed tax rises to fund defence. In Germany, 54% think the borrowing is excessive.
Energy closes the trap. In 2022 governments shielded households with subsidies and price caps worth hundreds of billions. The ECB notes that this year’s gas shock has been milder than 2022’s, with prices up about 53% rather than 79%, because Asian demand collapsed. But the cost of borrowing has changed. France’s ten-year yield is 4.9%, 130 basis points over Germany’s, and Paris needs an extra €10 billion next year just to service its debt. German interest costs are set to roughly double by 2030. The 2022 playbook of borrowing to cushion the shock is now affordable only in Berlin. That is why MD has warned this shock could leave lasting scars on European growth.
The strongest objection is that Europe has done this before. During the Cold War, West European states spent 3% of GDP or more on defence while building the welfare state. That is true, but they did it with growth rates near 4%, low public debt and an American guarantee that was not in doubt. Today growth is weak, debt is high, and Washington is rethinking its troop presence in Europe. The precedent shows the problem can be solved. It does not show it can be solved with national budgets alone.
So can Europe finance rearmament while protecting its social model and managing energy costs? Collectively, yes. Country by country, no, not for France, Italy, Spain or Greece. The missing piece is common financing. Friedrich Merz has called new joint borrowing “out of the question”, and the Netherlands, Austria, Finland and Sweden agree with him. Until that changes, each new shock will land on the weakest budgets first. That is what makes this crisis permanent.
Three Winters Ahead
Base case: two-speed rearmament (about 50%). Germany, Poland and the Nordic and Baltic states stay on course for 3.5%. France, Italy and Spain slip behind their targets while trimming welfare piecemeal, and Lecornu’s budget passes in diluted form in the first half of 2027, as he himself predicts. Bond spreads stay elevated without exploding. The key assumption is a normal winter and no further escalation in Hormuz. The cost is political: the burden falls on the countries where populist parties are strongest.
Downside: winter shock meets French fiscal crisis (about 30%). A cold winter, Qatar’s force majeure and Germany’s thin storage push gas above €100/MWh and force emergency demand cuts. In Paris the budget fails, the government falls and the spread over Germany widens sharply. Defence commitments become the first casualty, or street protests force the government to choose between pensions and procurement. Moscow, which has spent two years testing Europe with drones and sabotage, would read that as proof that pressure works.
Upside: the crisis forces common money (about 20%). Red Sea losses, Russian drones and France’s borrowing costs push Germany to accept a larger, defence-only joint borrowing instrument, a “SAFE 2”, inside the next EU budget negotiation. Berlin’s own doubling interest bill and its defence industry’s need for European orders make the case. That would move the cost of deterrence from the weakest budgets to the EU’s balance sheet. It is the only scenario in which the crisis stops being permanent.
Watch the Spread
Europe can afford to defend itself. What it cannot afford is to keep financing a common defence as 27 separate fiscal bets. Germany borrows, France cuts and Italy waits, and every gas spike and Houthi missile lands first on the budgets least able to absorb it. That is what turns a series of shocks into a permanent crisis.
The one thing to watch is the gap between French and German ten-year borrowing costs as Lecornu’s budget moves through a parliament without a majority. At 130 basis points it already prices real risk. If it moves decisively wider this winter, the market will have answered the question this piece asks. Europe’s front line runs from Narva to the Bab al-Mandeb, but the battle that decides whether it holds will be fought in the French bond market.
