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Global military spending hit a record $2.89 trillion in 2025, led by a 14% surge in European defense budgets to $864 billion, according to the Stockholm International Peace Research Institute (SIPRI). This once-in-a-generation rearmament push is fundamentally reshaping Europe's industrial policy, fiscal strategies, and supply chains — raising the strategic question of whether a defense-led industrial boom can coexist with the continent's green transition and social spending without triggering a fiscal crisis.
Record Military Spending: The Numbers Behind the Boom
The SIPRI 2025 data, released in April 2026, reveals the scale of Europe's military buildup. Germany increased its defense spending by 24% to $114 billion, crossing NATO's 2% of GDP threshold for the first time since 1990. Spain recorded the most dramatic surge among major European economies — a 50% increase to $40.2 billion, exceeding 2% of GDP for the first time since 1994. The United Kingdom spent $89 billion (down 2%), while France allocated $68 billion (up 1.5%). Ukraine ranked seventh globally at $84.1 billion, representing 40% of its GDP.
The global total of $2.887 trillion marks the 11th consecutive annual increase, with the global military burden reaching 2.5% of GDP — its highest since 2009. The United States remained the largest spender at $954 billion despite a 7.5% decline linked to the absence of new Ukraine aid packages. However, Congress has already approved over $1 trillion for 2026, with potential increases to $1.5 trillion in 2027. China increased spending by 7.4% to an estimated $336 billion, marking its 31st consecutive year of growth.
Defense Stocks Surge as Investors Bet on Sustained Growth
The spending boom has lifted defense stocks to extraordinary heights. German arms manufacturer Rheinmetall saw its stock surge 154% in 2025, while South Korea's Hanwha Aerospace soared 193%. Japan's Mitsubishi Heavy Industries rose 72.7%. Rheinmetall's order backlog reached a record €62.6 billion, with Q1 2025 revenue growing 46% and €11 billion in new orders. The company is divesting its civilian Power Systems division to become a pure-play defense powerhouse, reflecting a broader trend of European defense industry consolidation.
Analysts remain divided on valuations. Rheinmetall trades at 80.11x earnings, well above the aerospace and defense industry average of 46.07x. Using a Discounted Cash Flow model, Simply Wall St estimates an intrinsic value of approximately €3,017 per share, suggesting the stock is about 50% undervalued. However, critics note stretched valuations and the risk of geopolitical resolution leading to profit-taking.
Industrial Policy Transformation: From Fragmentation to Scale
Europe's rearmament push is driving a structural transformation of its defense industrial base. The European Defence Readiness Roadmap 2030, outlined by the European Parliamentary Research Service in 2026, addresses capability gaps, joint procurement, military mobility, and strategic autonomy. The European Sovereignty Fund, originally announced in 2022 to boost spending on green and cutting-edge technology, has increasingly shifted focus toward defense priorities.
McKinsey analysts highlight opportunities through consolidation in the European defense industry, noting that cross-border mergers, acquisitions, and strategic partnerships can enhance scale, improve technological capabilities, and reduce fragmentation. The NATO summit in The Hague in June 2025 committed allies to a new 5% of GDP defense spending target by 2035, with the Ankara summit in July 2026 expected to debate implementation details. This target, if adopted, would double the current 2% guideline and require unprecedented fiscal coordination among NATO members.
The Fiscal Challenge: Balancing Defense, Green Transition, and Social Spending
The European Central Bank (ECB) has warned that Europe faces unprecedented financing challenges. In a July 2025 blog post, ECB economists Bouabdallah, Dorrucci, Nerlich, Nickel, and Vlad calculated that annual strategic spending needs have surged from €800 billion to approximately €1,200 billion per year (2025-2031), with public financing needs rising to €510 billion annually. Even under optimistic scenarios combining existing EU mechanisms and national measures, a funding gap of at least €106 billion per year remains.
The New Economics Foundation warned in June 2025 that ramping up military spending risks crowding out investment in the green transition, not only financially but by tying up labor, industrial supply chains, and technical capacity that are already stretched. The Institut Jacques Delors, in a March 2026 study, argued that rather than opposing defense industrial policy and climate industrial policy, a coordinated approach could preserve jobs, maintain critical skills, and simultaneously strengthen the defense industrial base and energy sovereignty.
However, the EU green transition funding gap is widening as defense priorities consume an increasing share of national budgets. The European Sovereignty Fund, initially designed to boost green technology, has seen its resources redirected toward defense capabilities. This shift has sparked debate among member states about the long-term implications for Europe's climate goals.
Supply Chain Pressures and Strategic Autonomy
The rearmament boom is exposing critical vulnerabilities in European supply chains. A December 2025 report by Prima Sidera described Europe entering the most intense rearmament and industrial restructuring phase since the end of the Cold War, with unresolved supply-chain bottlenecks and shifting technological bases driven by dual-use innovation. Key bottlenecks include ammunition production capacity, advanced electronics, and rare earth materials.
SIPRI researchers have warned that NATO's new 5% GDP target risks incentivizing "creative accounting" due to vague spending definitions. The Atlantic Council's NATO defense spending tracker, updated April 9, 2026, shows European allies outpacing previous expectations with a 20% increase in defense spending in 2025. Norway has surpassed the United States in defense spending per capita for the first time in NATO history.
Expert Perspectives
"This is the fastest European military spending growth since 1953, driven by self-sufficiency efforts and NATO burden-sharing pressure from the US," said a SIPRI researcher. "The approved US budgets for 2026 exceed $1 trillion, with potential increases to $1.5 trillion in 2027, signaling continued growth ahead."
CleaRank's Senior Derivatives Strategist Jacob Bakshi, who targets €4,100 for Rheinmetall by November 2025, noted: "Record defense contracts, an EV pivot through its Sensors division, and geopolitical tensions are driving the stock. But Wall Street remains divided — 13 analysts rate it a 'Strong Buy' but with a €1,417 average target, implying 10% downside."
The European defense industrial strategy is evolving rapidly, with the EU's European Defence Fund and the European Peace Facility providing new mechanisms for joint procurement and capability development. The European Commission has proposed a Defense Investment Gap Analysis to identify critical capability shortfalls and align national spending with EU priorities.
FAQ
What is driving the surge in European defense spending?
The primary drivers are the war in Ukraine, NATO burden-sharing pressure from the United States, and a broader shift toward European strategic autonomy. The new NATO 5% GDP spending pledge, adopted at the Hague summit in June 2025 and to be debated at the Ankara summit in July 2026, is accelerating national commitments.
How is the rearmament boom affecting European economies?
Defense spending is creating an industrial boom, with companies like Rheinmetall and Hanwha Aerospace seeing stock surges of 154% and 193% respectively. However, it is also straining public finances, with the ECB estimating a funding gap of at least €106 billion per year for combined defense, green, and digital transitions.
Can Europe afford both defense spending and the green transition?
This is the central strategic question. The ECB warns that without deeper EU integration and new fiscal measures, the funding gap is unsustainable. Some analysts argue for a coordinated approach that leverages dual-use technologies and aligns defense and climate industrial policies.
What are the risks of the 5% GDP NATO spending target?
SIPRI researchers warn of "creative accounting" due to vague spending definitions. The target could also crowd out social and green investments, trigger fiscal crises in highly indebted member states, and exacerbate inflation pressures in defense supply chains.
Which defense companies are benefiting most?
Rheinmetall (Germany, +154%), Hanwha Aerospace (South Korea, +193%), and Mitsubishi Heavy Industries (Japan, +72.7%) have seen the largest stock gains. European companies with large order backlogs and exposure to NATO procurement programs are best positioned.
Conclusion: A Strategic Crossroads
Europe's defense industrialization represents the most significant economic transformation on the continent since the post-Cold War drawdown. The SIPRI data confirms that the rearmament boom is real, sustained, and reshaping industrial policy, fiscal strategies, and global supply chains. As NATO prepares for its July 2026 Ankara summit, where the 5% GDP spending pledge will be debated, the strategic question is whether Europe can sustain this defense-led industrial boom without sacrificing its green transition or triggering a fiscal crisis. The answer will depend on the continent's ability to innovate fiscally, coordinate industrially, and prioritize strategically — a challenge that will define European economic policy for the remainder of the decade.
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