Europe summer 2025: Headlines galore – RBC Wealth Management

Coming in “thick and fast”

A key pillar of the euro area growth recovery over the next few years is
Germany’s renewed fiscal drive. According to RBC Capital Markets, recent
announcements point to not only very sizeable, but also front-loaded,
spending, in its words, “thick and fast.”

In a radical shift from many years of fiscal prudence, the German
government announced in March that it would:

• Create a 10-year €500 billion infrastructure fund which would not count
  towards the government’s borrowing limit and
• Stop counting any defense spending above one percent of GDP towards that
  limit.

The Federal Ministry of Finance announced concrete figures behind these
pledges in late June.

The German government is front-loading its special infrastructure fund,
with around €58 billion by 2026, alongside some €25 billion in annual
defense spending. Peak stimulus and the deepest fiscal deficit are
penciled in for 2026.

Moreover, the details released by the Finance Ministry show that a high
share of the spending is going to areas which should boost economic
growth. In 2025 alone, €22 billion, or about 0.5 percent of German GDP, is
going to rail sector improvements. Furthermore, there is €4 billion per
year for housing projections, €4 billion for digitalization, and
€6.5 billion for education and childcare.

RBC Capital Markets expects this spending to be a substantial stimulus for
German and, therefore, euro area growth in 2025 and 2026, though the
stimulus should fade beyond that point. This increases RBC Capital
Markets’ confidence in its slightly above-consensus growth estimates of
1.3 percent and 1.5 percent, respectively, for this year and next for the
bloc as a whole.

Front-loaded spending will deepen Germany’s deficit

German Finance Ministry’s deficit expectations (% GDP)

The trade deal beyond the headlines

The U.S. and the European Union (EU) reached a deal in late July that
introduces 15 percent tariffs on most EU exports, including automobiles,
pharmaceuticals, and semiconductors. Tariffs on steel and aluminum remain
subject to global tariffs of 50 percent, though discussions are ongoing
regarding possible reductions.

Furthermore, the European Commission, which negotiated the terms of the
deal on behalf of member states, committed to the EU investing
$600 billion in the U.S. economy and purchasing $750 billion in U.S.
energy exports over the next three years.

Initially, the deal was poorly received in Europe. The 15 percent tariffs
were higher than the 10 percent tariffs which had been in place since
April 2025, so it seemed the EU had capitulated. This disappointed many
observers given the EU market of 450 million people with high per-capita
spending power is a geo-economic force.

We note, however, that the agreed-upon tariff is lower than the 30 percent
U.S. President Donald Trump threatened in June. And while the 15 percent
rate doesn’t compare as favourably with the UK’s 10 percent tariff, the
torrent of trade deals with other trading partners announced since then
feature tariffs that are at or above 15 percent, suggesting to us that the
EU is not in a weaker competitive position after all.

The concessions made – the promise of higher European investment and energy
purchases – cannot be fulfilled by the European Commission. While it has the
authority to negotiate trade deals, it has no power over private
investment, nor does it have the authority to tell companies where to buy
energy. The RBC Capital Markets Commodity Strategy team is skeptical that
$750 billion in U.S. energy can be delivered to the EU in the next three
years.

Finally, the EU has not given up regulating U.S. multinationals on
European soil, nor its power to impose a digital services tax (it still
holds those valuable cards).

Meanwhile, it appears that Trump has abandoned the idea of treating the
value-added tax – a sales tax typically over 20 percent – levied by EU member
states as an unfair tax barrier to U.S. exports.

Overall, we believe this deal is not as disadvantageous to Europe as early
reactions have suggested.

Buoyed sentiment?

After a strong start to the year, and a swift recovery from the April 2
reciprocal tariff announcement correction, European equities have stalled
this summer, their performance overshadowed by that of the U.S. tech
sector and currency moves. But overall, the STOXX Europe ex UK Index has
still returned over 13 percent year to date in local currency terms
(including dividends), ahead of the S&P 500’s 9.5 percent return in dollar terms. Thanks to the significant U.S. dollar weakening versus the
euro this year, returns of the STOXX Europe ex UK are around 28 percent in
U.S. dollar terms.

Performance has been driven by value stocks including banks (up almost
60 percent in local currency), with construction and materials, insurance,
and utilities all gaining more than 20 percent. Most quality stocks have
underperformed, partly reflecting the market rotation into value but also
a range of idiosyncratic factors resulting in earnings downgrades.

Looking forward, we believe a diplomatic resolution to the Ukraine
conflict could act as a positive catalyst for European equities. Hope of
reconstruction efforts could arise though this would require hostilities
to come to a sustainable end. If that were to be the case, banks,
particularly those with Central and Eastern Europe exposure, would likely
benefit, in our opinion, as would construction and aggregate firms. Lower
energy prices, thanks to reduced transport and insurance costs, could also
benefit the region but the price improvement is likely to be marginal as
EU sanctions on Russia will likely persist, even with an eventual
ceasefire.

Overall, while sentiment could improve in the short term for European risk
assets on the back of seemingly successful diplomatic efforts, we caution
against being overly optimistic about an immediate, lasting end to the
hostilities as the issues associated with this are complex.

Regardless, in our view, the investment case for Europe remains, based on
an economic recovery thanks to lower interest rates, the German fiscal
program, and the EU’s commitment to investing in its defense industry.
The STOXX Europe ex UK Index trades at 16.2x the next-12-months consensus
earnings forecast, slightly above its long-term average, a premium we
believe is warranted given the region’s improved medium-term growth
outlook.

We continue to prefer sectors we think are likely to benefit from the
fiscal stimulus, such as select industrials, including defense, and
materials. In our view, banks should benefit from the region’s improved
medium-term growth outlook, while continuing to offer attractive dividends
and share buybacks opportunities.

With contributions from Thomas McGarrity, CFA