Europe in the context of geopolitical change: The future of defense spending, banks, climate stress tests and foreign investment

The Fed and ECB are on diverging monetary paths in 2025, with the U.S. prioritizing inflation control while Europe races to lower rates to revive growth within the context of structural weaknesses. Trump’s tariff threats and the Big Tech-driven stock market rally add layers of complexity to an already volatile financial landscape where any misstep could trigger a global market correction.
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President Donald Trump’s second term will be even more disruptive to transatlantic relations than his first, as Trump has already threatened to impose tariffs on the EU, which could be more severe if the bloc does not significantly boost defense investments and U.S. imports. EU leaders must manage the difficult task of maintaining unity within the weakened 27-member bloc as they explore negotiating strategies, evaluate proposals for increasing defense spending, and responsibly reduce the trade deficit while ensuring strategic autonomy, competitiveness, and fiscal stability; however, reaching the latest proposed targets for boosting EU defense spending does not appear feasible.
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Climate stress testing for the financial sector has arrived, with the most recent EU climate stress tests revealing that the impact of transition risks on banks was low – not surprising given banks' moderate direct exposure to climate risk. More generally, the methodology of EU climate stress testing is constrained by scope, timelines, and data, suggesting revisions are necessary to improve their usefulness.
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The outlook for European banks remains solid in 2025, with improving economic growth and rising risk appetite supporting activity, despite falling interest rates; nevertheless, risks related to interest rates, growth, debt, geopolitics and various political or policy issues, including EU–U.S. trade tensions remain. Banks appear poised to increase investment in technology and artificial intelligence (AI) to boost efficiency and control costs.
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European and U.S. policymakers seek to balance their desire to attract foreign investment while enhancing regulatory scrutiny of acquisitions by geopolitically sensitive SWFs, state-owned enterprises, and associated entities. The increased focus on investment screenings –both inbound and outbound– to safeguard national security and economic sovereignty could also contribute to geopolitical polarization, economic decoupling, and shifts in the global economic order.
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