This summer started with optimism around trade deals and progress in Ukraine, but quickly unravelled. Trade uncertainty is back, the war drags on with rising casualties, and Europe is now grappling with a raft of political crises and a deepening bond market storm on the back of inexorable rising debt in the G7.

Europe’s relations with the US, formerly its largest trade partner and the guarantor of European security, is fundamentally broken. German Chancellor Friedrich Merz said in a big foreign policy speech on September 8 that the EU must look for new trade partners as the US is no longer a reliable ally.

“We must face the fact that our relationship with the US is changing,” said Merz in Berlin in a wide-ranging foreign policy speech. “The US is reassessing its interests — and not just since yesterday. And so we in Europe must also adjust our interests, without false nostalgia.”

Merz has tried to build a close relationship with Trump, but when he was presented with pleas for concrete help in supporting Ukraine or trade deals, he was met with a brick wall.

“We must be even more proactive than we have been so far in forging new partnerships around the world and expanding and strengthening existing ones,” he said., going on to name China as a potential key ally, but emphasising South American countries as well as India, Indonesia and Mexico, as a better bet.

European Commission President Ursula von der Leyen called Europe a club of traders in her EU State of the Union address (video, transcript) on September 10, and roundly criticised for caving into to the one-side trade deal she cut with US President Donald Trump which imposed a 15% tariff on Europe, while throwing open Europe’s markets to American companies.

“The US-EU trade deal exposed Europe’s vulnerabilities and dependencies, showing that the EU is, sadly, more of a deal-taker than a dealmaker,” said Carsten Brzeski is the Global Head of Macro for ING Research. “Just because we don’t see the cracks now doesn’t mean they aren’t forming. This is especially true for tariffs. Companies – both American and foreign – can only absorb higher costs for so long. Eventually, those costs will be passed on to consumers or lead to reduced production. In Europe, this is reportedly already happening.”

Big bills

As bne IntelliNews has argued, Europe can’t afford to take over the burden of supporting Ukraine, as most EU countries are either in recession or approaching a crisis.

Money is tight in almost every EU member country. Even Germany, which is nominally in the best shape of the leading EU power, is running out of cash. Bild cites a Federal Ministry of Defence (BMVg) document that was circulated to Bundestag members at the end of August and shows the Defence Ministry submitted a request to the Finance Ministry in June for €15.8bn for 2026 and €12.8bn for 2027 for military support to Ukraine. Ultimately, only €9bn for each year was approved, of which €500mn will be reimbursed from EU funds. The ministry is now short €10.6bn for critical and partly committed Ukrainian defence initiatives.

Looking ahead and Europe has two giant bills to pay: €800bn over the next five years to cover defence spending to modernise its military as part of von der Leyen ReArm programme; and the even more expensive €800bn per year that Mario Draghi called for in his report issued a year ago that laid out in detail how Europe is no longer competitive.

With defence spending due to hit €170bn this year the first bill can be paid. The second one cannot and all serious attempts to make the changes Draghi has been demanding have got lost in the cacophony surrounding the need to support Ukraine.

“As we mark the first anniversary of the famous Draghi report, Europe’s core weakness is once again laid bare: it’s not the analysis or awareness that’s lacking, but the willingness – and ability – to implement meaningful change. Yes, there have been attempts to cut red tape and launch new initiatives, with flashy names like the “Competitiveness Compass” and the “Clean Industrial Deal.” But beyond German fiscal stimulus and defence efforts, little of substance has changed. Most of Draghi’s recommendations have been watered down, slimmed down, or – predictably – run into resistance at the member state level,” says Brzeski.

Europe’s political elite are caught between the rock of trying to replace the US in preventing Ukraine from losing its war with Russia and the hard place of stagnant economies and making cuts to fund the war effort that are stoking the rise of right-wing parties across the Continent. Afraid drastic action will only make them more unpopular, the leaders are afraid of taking the bold action needed and forced into simply “managing the decline,” says IntelliNews columnist Liam Halligan.

“As Jean-Claude Juncker once said: “All government leaders know what to do. They just don’t know how to get re-elected if they do it.”

Germany to splurge on investment and defence

With relatively low debt (69% of GDP) and a new borrowing facility at its disposal after the constitutional Schuldenbremse borrowing restrictions were eased, Berlin is one of the few European capitals to be able to borrow and spend its way out of lethargy. Germany has already been in recession for the last three quarters in a row and is facing more contractions ahead.

German Chancellor Friedrich Merz has promised to spend €400bn on the investment and defence sector. Oxford Economics says the federal deficit could more than double, averaging close to 4% of GDP over the next four years, as a result – the highest it has ever been outside of a crisis year.

“The German government has initiated an ambitious fiscal easing. But its investment-heavy nature, large scale, and focus on sectors that are already at capacity amid a tight labour market make delays likely. Past experience indicates that a 10% shortfall in the infrastructure and defence plans is feasible, which could decrease next year's GDP growth by as much as 0.4ppts,” Oxford Economics said in a note on September 15.

Germany’s strongest headwind in the medium term for a structural ramp-up in investment-related spending is the tight labour market. Unemployment remains one of the lowest in Europe, surveys show that labour supply shortages remain significant.

Another problem is that the defence sector has a big recipient of investment in recent years, but is already running at capacity and will not be able to absorb even more spending that Berlin is intending to lavish on the sector, says Oxford Economics.

Deindustrialisation accelerates

Germany’s deindustrialisation is accelerating. Energy prices have fallen from the 2022 energy crisis peak levels, but remain twice what they were pre-war. Some 10% of Germany’s heavy industry has already closed down or moved abroad and other less strategic industries are now shedding workers and trying to cut costs. In general EU growth of 1.3% is expected this year and 1.2% in 2026, according to ING.

Volkswagen has already done a deal with the IG Metal union to cut thousands of jobs to avoid closing two factories, but the company is struggling as demand slumps and competition from China rises.

Porsche is also reportedly planning drastic cuts at its battery subsidiary Cellforce Group, effectively shutting down most of its operations in Kirchentellinsfurt, and laying off most of its staff. according to Der Spiegel.

This closure follows the collapse of Sweden’s Northvolt AB that went bust this year ending Europe’s aspirations to be able to compete with China’s burgeoning battery making industry. Likewise, Cellforce was originally founded as a joint venture to develop high-performance batteries and reduce reliance on Asian suppliers, particularly China. Technical missteps, rising costs, and weak demand in the luxury EV segment led to its downfall. Now, Porsche will outsource battery production to Chinese giant CATL, abandoning its ambitions of European self-sufficiency.

Europe has already lost solar panel production, and this year also lost EV production when China’s BYD sales went to number one in April. Now it has lost batteries too.

Steel is another industry where steelmakers are pleading with Brussels for protective tariffs on cheap imports, warning the industry risks collapse under pressure from cheap Chinese products and Donald Trump’s high duties.

“We need protection [or] we are not going to survive as a steel industry,” Ilse Henne, a senior executive at Germany’s Thyssenkrupp, told the Financial Times on September 7. The EU’s steel industry was already struggling with high energy prices before the US president slapped 50% tariffs on their exports to America earlier this year. EU steelmakers were forced to make 18,000 job cuts in 2024, according to trade body Eurofer, adding to the 90,000 laid off since 2008.

The sector expects to lose most of the 3.8mn tonnes it exports to the US annually as a result of Trump’s tariffs. Eurofer said in a letter this month to Von der Leyen, seen by the FT, “Effectively, the EU steel industry is the worst off of all EU industries.”