Europe wants to spend more but its own policies are making it harder

Just as Europe prepares to pour money into defence, infrastructure, grids and the green transition, borrowing costs are rising across the bloc. France will spend around six percent of government revenue servicing old debt, compared with three percent in 2019. German bund yields are now at their highest since 2011. And borrowing costs are rising just as debt issuance is surging. Germany created a €500bn infrastructure fund last year and suspended its debt brake for defence; its 2026 federal budget alone needs nearly €180bn in borrowing. And bond issuance across Europe is running at a record pace. There are several reasons borrowing costs are going up besides bond issuance. The most immediate is the Iran war, which has pushed energy prices up and eurozone inflation to 3.3 percent in August, its highest in nearly three years, and bond buyers are asking for a higher return to account for that. By June, borrowing costs across the eurozone had already risen by around half a percentage point since the war began. Meanwhile the ECB has stopped reinvesting its bond holdings, leaving markets to absorb roughly €384bn more this year. ECB’s chief economist Isabel Schnabel estimates this has already added around 0.6 percentage points to euro-area borrowing costs. Another factor is the US AI boom. Searching for ever more sources of finance, US tech giants are increasingly issuing long-dated corporate bonds in European markets. Because these highly-rated bonds compete for the same buyers as government debt, the ECB warned this week that they could push borrowing costs even higher. And some of the changes in the bond markets may be structural. Under its Savings and Investments Union, the EU Commission wants more retirement money channelled into shares rather than bonds. And pension reform is changing demand for bonds too. The Netherlands alone is moving roughly €1.5trn of pension assets to a defined-contribution system. Individuals have less need to lock money away for 40 years, so demand for long-dated bonds is expected to fall. These are precisely the bonds used by governments, the EU and institutions such as the EIB to finance things like railways and power grids. Rising interest rates Then, the ECB is set to raise rates again next week, to 2.5 percent. That increases the cost of investments Europe says it needs. Renewables, for example, are especially sensitive to higher rates because they are often debt funded and 70 to 80 percent of costs are paid upfront. After the ECB began pushing rates up in 2022 by 4.5 percentage points in all, investment in new European offshore wind projects all but stopped. Four economists writing for the European Parliament argued in June that indiscriminate tightening risks making Europe more dependent on fossil fuels. If tightening is necessary, they said, the ECB should shield renewable and cleantech investment. Brussels think-tank Bruegel has separately called for the ECB to slow the shrinking of its bond portfolio. Teresa Ribera, the EU’s green transition commissioner, for her part, said the EU should issue joint EU debt to climate-proof the continent. But with borrowing costs rising and governments already spending more on debt service, that is becoming even harder to pull off than before. Europe wants to invest more. But it does so precisely at a time when the cost of doing so is rising too.