For years, Germany was the country Europeans could rely on to keep the finances of the eurozone in check. Its reputation was built around fiscal discipline: balanced budgets, low debt and an almost obsessive commitment to its constitutional "debt brake".

That reputation is now changing. Germany has begun to borrow on a scale that would have been difficult to imagine only a few years ago, largely to finance defence and infrastructure. At the same time, France, Italy and other European governments are facing their own large financing requirements. The result is beginning to show up somewhere that arguably matters far beyond government ministries: the bond market.

Germany's 30-year government bond yield reached 3.79% this week, its highest level since 2011, while French thirty-year borrowing costs have reached 4.92%, their highest since 2008, with French yields more broadly close to an eighteen-year high.1

Bond yields determine how expensive it is for governments to borrow, but they also influence mortgage rates, business investment and the wider cost of credit. What is happening in European bond markets therefore raises a much larger question. Can Europe afford the spending it increasingly believes it cannot afford not to do?

Europe has decided it needs to spend

The immediate reason for Europe's fiscal transformation is security.

Russia's invasion of Ukraine and the wider deterioration in Europe's geopolitical environment have forced governments to reconsider decades of relatively low defence spending. Germany, in particular, has undergone a dramatic shift.

For years, Germany's fiscal policy was constrained by its debt brake, which placed strict limits on structural federal borrowing. The constitutional amendment passed in March 2025 changed that. Defence spending above 1% of GDP is now exempt from any borrowing limit, and the reform created a €500 billion extrabudgetary fund for infrastructure, €100 billion of it earmarked for climate-related investment, to be spent within twelve years. Bruegel estimated at the time that the reform may already have pushed euro-area real interest rates up by around 30 basis points.2

Germany is therefore entering the bond market with a much larger appetite for borrowing than investors have been accustomed to. Commerzbank estimates that German gross bond supply will reach a record €400 billion in 2027, up from €349 billion this year. And Germany is not alone. European governments are simultaneously trying to finance defence, infrastructure, ageing populations, healthcare and the energy transition. Barclays estimates that gross eurozone bond supply could reach a record €1.54 trillion in 2027, with net issuance of €574 billion. As Ales Koutny, head of international rates at Vanguard, put it, "there's a lot of money that needs to be raised in bond markets, and yields are adjusting to reflect that".1

This creates a surprisingly simple problem. There are suddenly a lot more European governments asking investors for money.

There's a lot of money that needs to be raised in bond markets, and yields are adjusting to reflect that.

Ales Koutny, Head of International Rates, Vanguard.

When everyone wants to borrow

To understand why this matters, we need to return to the fact that bond prices and bond yields move in opposite directions. If the supply of bonds increases and demand does not rise by enough to absorb them, bond prices fall. The yield investors receive therefore rises. This is particularly important for long-term bonds as investors are naturally going to care about what inflation, government debt and economic growth might look like over a long period of time.

This helps explain why Germany's long-term yields have risen so sharply. The interesting part is that Germany is not necessarily being punished for being fiscally irresponsible. Instead, investors are adjusting to the fact that Germany is no longer the ultra-low-debt borrower it once was.

Germany can borrow more cheaply than countries such as France or Italy because investors still regard German debt as relatively safe. But the risk-free rate itself is rising, which has consequences for everyone.

The ECB is no longer doing the heavy lifting

For much of the 2010s and early 2020s, European governments benefited from the European Central Bank as an extraordinary buyer of their bonds. Through quantitative easing, the ECB purchased enormous quantities of government debt. The effect was to increase demand for bonds and push their yields down. This made it significantly cheaper for governments to borrow.

But that is now changing. The ECB has been allowing bonds acquired under its asset-purchase programmes to mature without fully reinvesting the proceeds, gradually reducing its footprint in European bond markets.3 This means private investors increasingly have to absorb the debt that governments are issuing. Private investors are also less willing to accept extremely low returns.

The result is a bond market where supply is rising at exactly the moment that one of its largest traditional buyers is retreating.

The ECB is not only stepping back, but is also pulling in the opposite direction. It raised rates in June and held them at its July meeting, leaving the deposit facility at 2.25%, and by late August traders were pricing roughly 45 basis points of further tightening before the year is out, up from 40 a week earlier.3 The trigger is not fiscal at all. The main driver is due to a diplomatic deadlock in the Gulf that has pushed oil prices higher and revived inflation fears across the euro area, and Reuters attributed part of the bond selloff directly to inflation concerns tied to the Iran war. Supply and geopolitics are pulling yields in the same direction at once.

While this is not necessarily a crisis, it is a very different financial environment from the one Europe became accustomed to during the age of quantitative easing.

Another interesting case study is France. France already has a much heavier debt burden than Germany and has struggled to convince investors and politicians that it can bring its deficit under control.

French bond yields have consequently risen much more sharply than German ones. Its 10-year borrowing costs have reached their highest level in years, while political uncertainty surrounding the government's budget has added another layer of risk.4 This creates what economists call a sovereign spread.

Germany's 10-year government bond is generally treated as the benchmark for euro-area borrowing costs. If Germany can borrow at, say, 3.2%, but France has to pay 4%, the difference between those yields reflects the additional risk investors associate with France. The larger that spread becomes, the more expensive French debt becomes relative to Germany. This matters because debt has a compounding characteristic.

A government does not simply pay interest on the money it borrowed this year. When old debt matures, it needs to refinance it. If interest rates are higher when that happens, the new debt costs more. Therefore higher interest payments then put additional pressure on government finances. This creates the uncomfortable cycle of more bonds (due to the increased borrowing), thus higher yields, higher interest payments and thus greater fiscal pressure.

Europe is not facing an immediate recession

Euro-area GDP grew by 0.4% in the second quarter of 2026, following stagnation in the first quarter. The economy was 1% larger than a year earlier.5 All of this proves that Europe isn't necessarily suffering an immediate crisis. The question is whether additional spending generates enough economic growth to justify the additional debt. Therefore it would be wrong to describe this as another eurozone debt crisis.

Europe's institutions are considerably stronger than they were during the sovereign debt crisis of the early 2010s. The ECB has tools designed to prevent disorderly financial fragmentation, and Germany's debt remains relatively manageable compared with many other advanced economies. German government debt stands at just over 60% of GDP, against roughly 120% in the United States, and the triple-A rated sovereign is not attracting the same level of concern as some larger borrowers. German ten-year yields have risen 40 basis points this year, slightly less than the 50 basis points added by US Treasuries.6 That comfort is a snapshot rather than a trajectory, however. On plausible growth and defence-spending assumptions, Bruegel projects German debt converging at around 100% of GDP.2

European financial markets have also remained surprisingly resilient. The STOXX 600 is close to record highs, while investor flows into European equities have strengthened this summer.6

The problem is therefore not that Europe is about to collapse under its debt but rather that the economic environment that made high government borrowing relatively painless is disappearing.

For years, Europe enjoyed extremely low interest rates, abundant central-bank liquidity and cheap government financing, which is now gone. This means that governments now have to make difficult choices about what they spend, how they finance it and whether the resulting investment actually raises future growth.

If Europe's new spending produces higher productivity, stronger infrastructure and greater security, today's debt could prove to be an investment. If it does not, rising yields could turn today's fiscal expansion into tomorrow's fiscal constraint.

Footnotes

  1. Reuters, Record German debt sales deepen strains for Europe's battered bond market (opens in a new tab), 21st August 2026. 2

  2. Bruegel, What does German debt brake reform mean for Europe? (opens in a new tab), 31st March 2025. 2

  3. European Central Bank, Economic Bulletin, Issue 5/2026 (opens in a new tab), August 2026. 2

  4. Reuters, Record German debt sales deepen strains for Europe's battered bond market (opens in a new tab), 21st August 2026Trading Economics, Germany 10-Year Bond Yield (opens in a new tab), 21st August 2026.

  5. Eurostat, GDP up by 0.4% and employment up by 0.1% in the euro area (opens in a new tab), 14th August 2026.

  6. Reuters, War-hit European markets are far from down and out (opens in a new tab), 21st August 2026. 2