When Polish, Dutch and Italian warplanes scrambled in the early hours of last Wednesday in an operation to shoot down Russian drones that had crossed into Polish airspace, it marked an important landmark.

This was the first time NATO had engaged directly with Moscow’s forces during the war in Ukraine. Many European leaders believe this, and other incursions by Russian drones and missiles along NATO’s eastern flank, are not accidents. They are deliberate tests of the alliance’s preparedness and resolve.

Which brings us to defence spending.

As our chart shows, Europe’s defence spending has inched higher since 2014, but it still falls short of what many experts believe is necessary to deter Russian aggression, without US backing.

Many European Union countries have failed to meet the existing target for NATO members of spending 2% of their gross domestic product (GDP) on defence. Now the alliance’s members have made a commitment to spend 3.5% of GDP on ‘core defence’ by 2035, with another 1.5% on more broadly defined investments in security infrastructure.

If European countries honour this commitment – and the incident last week is likely to have further focused minds – then the implications for investors are twofold:

- A potential medium-term re-rating of European equities: Rising defence budgets could strengthen cohesion across the bloc, reducing the “disharmony discount” that has weighed on sentiment towards European equities.

- Sector opportunities: Defence companies and those in associated sectors are likely to benefit if spending increases and governments push for joint projects.

Key takeaway

We’re not making investment decisions based on NATO’s response to the Russian drone incursion last week. But Europe may soon find that a sustained increase in investment in its own security is unavoidable. And that shift could make the investment case for Europe look stronger too.

‍

‍Find out more about our multi-asset solution

‍

This article is provided for general information purposes only and should not be construed as personal financial advice to invest in any fund or product. These are the investment manager’s views at the time of writing and should not be construed as investment advice. The opinions expressed are correct at time of writing and may be subject to change. Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.