I Ukraine have had a generally excellent week, as Donald Trump (surprising me) imposed his first material economic sanctions against Russia, permitted US data to be used for targeting European made cruise missiles against military industrial targets inside Russia, and the EU passed the 19th sanctions package and outlined the eventual total stop for all fossil fuel imports no later than the end of 2027. Ukraine, however, did not in the end get a concrete path forward from the EU for how Europe will provide the necessary financial assistance for Ukraine in 2026 and 2027, as leaders meeting in Brussels failed to agree to a specific proposal on the so-called Reparations Loan. Instead, EU leaders invited “the Commission to present, as soon as possible, options for financial support based on an assessment of Ukraine’s financing needs and invites the Commission and the Council to take work forward, in order for the European Council to revert to this issue at its next meeting [in mid-December]“. In other words, EU leaders postponed what has turned out to be a tougher decision than expected. It nonetheless for several reasons remain the strong base case that the EU will by mid-December authorize a Reparation Loan to Ukraine, politically linked to immobilized Russian assets held in especially Belgium and six other EU jurisdictions.
First of all, it is clear that failure by the EU to provide adequate financial support to Ukraine in 2026-27 could prove disastrous for Kyiv’s ability to maintain its defense against Russia’s ongoing attacks. Neither the U.S. Congress nor other G7 members are likely to continue their large-scale financial support. It is – appropriately given its economic size and adjacency – up to the EU (and other European countries) to adequately support Ukraine, and failure to do so would evidently increase the future military risk to the EU itself dramatically. There are indeed “other options” available for the EU to provide required assistance to Ukraine – $45-60bn/year is not insurmountable for a rich group of countries with a GDP of about $24bn, but it is clear that many governments would prefer not to ask national parliaments for such additional commitments to Ukraine at this moment. The EU further has the particular problem that issuance of joint debt, like happened during the Covid19 crisis, requires unanimity among the 27 member states and Hungary’s pro-Russian soft autocratic leader Viktor Orban is certain to reject this. Once the Commission considers “other options” to adequately assist Ukraine, everyone is by mid-December likely to come back to look at how to make a Reparation Loan work.
Secondly, it seems from leaders’ comments after their meeting in Brussels that there really were serious concerns raised by especially the Belgian prime minister at the meeting and that these were echoed by ECB president Lagarde also present. These concerns focus on three particular areas.
- There is the strictly legal issue regarding how under international law, sovereign assets can be first immobilized (already done in February 2022), then partially tapped for asset returns (done in 2024 with the G7 ERA loan of $50bn to Ukraine), and now to be given to Ukraine in exchange for some kind of “European IOUs” to make EuroClear and other financial institutions’ assets and liabilities balance. There is no legal precedence to rely on for the European Commission and European governments, and differing legal options and lawsuits seem inevitable. International lawyers with the relevant expertise can look forward to a lot of billable hours between now and mid-December, but it is an iron law of EU affairs that “where there is a sufficient political will, a legal way will be found”
- Then there is the highly political issue of the nature of the “liquidity guarantee” to EuroClear and other affected financial institutions. Who can issue such a guarantee ensuring that the cash would actually be there in the event of a “peace involving Russia getting its assets back” suddenly breaking out? Here it is important to understand that it is the EU itself which decides when to lift economic sanctions on Russia and hence going forward potentially make the “IOU” come due, evidently raising the bar for what kind of peace agreement with EU (and Ukraine) would be willing to accept to lift sanctions. In some ways, a reparation loan would give the EU a carrot (sanctions lifted) to offer Russia if it paid reparations to Ukraine, removing the need for the EU to make good on the “IOU”, which might be more effective than sticks to convince a nuclear power to cough up. Using the EU budget itself to issue a “liquidity guarantee” backed by contingent commitments to if required issue new debt might be possible but would again require the acceptance of Viktor Orban. He might though be ousted at the upcoming April 2026 Hungarian elections, making only a very short-term temporary other liquidity guarantee necessary – IF you are willing to bet on a change of government in Hungary happen soon. In reality, however, it is unlikely that the EU budget can be used as the guarantor until the next long-term budget comes into force in 2028, so the EU needs something else until then. This almost invariably requires some sort of guarantee from member states between now and then, which in turn likely requires national parliaments to vote on these. In places like France, such a vote would likely be difficult, at least until the 2026 budget is eventually voted through likely towards the very end of the year. Perhaps the creative use of the otherwise inactive ESM might be possible, or other European institutions – this is what the European Commission has to find out between now and mid-December, potentially setting up a host of national parliamentary “last thing before Christmas votes” in member states to provide the guarantees to Ukraine. This would be a process akin to what is so often seen in the US Congress to get year-end fiscal packages through at the last minute.
- Lastly there is the more diplomatic issue related to the advantages under international law and likely also for broader political considerations of getting other especially G7 jurisdictions holding immobilized Russian assets to join an EU “Reparations Loan” to Ukraine. This would likely particularly pertain to the U.K. and Canada, but could also be extended to Japan and other third countries. Both the U.K. and Canadian government have previously indicated a desire to tap immobilized Russian assets directly, while the stance of the new Japanese government is less clear. It was evident from comments made after the EU leaders met that especially ECB president Lagarde emphasized the benefits of involving multiple jurisdictions in a Reparations Loan. Hence, as is the case with EU lawyers, EU diplomats can also look forward to a very busy schedule between now and mid-December.
Ultimately, it is after this week clear that it is not just Belgian intransigence and there are real concerns to overcome before an EU reparations loan can be a politically agreed. Yet, once these concerns are laid out and the dire consequences of no actions and alternatives are considered, it remains the strong base case that a way will be found for an EU Reparations Loan to be given to Ukraine at the next Eu Council meeting in mid-December. This will ensure that Ukraine remains funded also the coming years, even if agreement like in so many politically difficult and expensive issues is found only “a few minutes before midnight”.
II October Euro area flash PMIs showed composite output levels growing at the fastest rate in over a year, while a noteworthy if predictable divergence between short-term stronger data in Germany and weaker in France is developing, as German fiscal stimulus begins to take effect and political uncertainty continues in France. Yet, with no new updates to the ECB economic forecast available at next week’s ECB rate setting meeting, but renewed uncertainty especially concerning the impact of potential restrictions on Chinese rare earth exports to Europe has emerged, improved short-term data are extremely unlikely to sway governing council members one way or another. There is hence essentially no chance of a change in rates by the ECB next week.
The next ECB rate-setting meeting comes in December, where a new updated economic forecast including for the first time 2028 will be available. While the inclusion of a new year in the forecast always allows for “new 3y trends” to suddenly emerge, especially pertaining to projected growth and inflation, the probability that having 2028 in the time series will somehow cause a majority of the council to change rates is very very low. Given the existing forecast pointing to a risk of inflation undershooting in both 2026 and 2027, it though warrant notice to see if the ECB’s December forecast projects a 3y HICP inflation undershoot, especially if excluding a probable upward inflation change from the planned ETS2 expansion of EU carbon pricing during 2027. Such a 3y undershoot, even if by only a small margin, could prompt a debate on the governing council later in 2026 regarding whether another “insurance rate cut” against too large/prolonged an undershoot of a “symmetric mandate” might be warranted.
In other words, as discussed also in earlier notes regarding the risk that private consumption in the euro area will not increase much until the war in Ukraine stops in a satisfactory manner for Kyiv, despite Christine Lagarde’s public statements, the medium-term risks to the euro area inflation outlook are in fact not balanced, but remains tilted to the downside.
Jacob
