By Joshua Kirby

Europe's industrial production recovered at the start of a year that could see major investment in defense and a new dawn for the beleaguered manufacturing sector.

Production in the 20 nations that share the euro rose in January on month, rebounding from a drop in December. But compared with a year earlier, production stagnated, extending a slump that began with Russia's full-scale invasion of Ukraine in early 2022.

"Output remains well below its levels prior to the energy crisis," Capital Economics' Ankita Amajuri said. "The near-term outlook remains poor."

However, ambitious plans to boost defense investment--a response to growing doubts about the reliability of the U.S. as an ally in the face of potential Russian aggression--may lift Europe's manufacturers out of their torpor by finding a new purpose for underused factories.

"Between producing cars and producing tanks, there is some connection," said Pierre Wunsch, head of Belgium's central bank, in a recent interview with The Wall Street Journal.

German arms maker Rheinmetall could take over plants from carmakers like Volkswagen Group, its chief executive told analysts Wednesday.

"One thing is clear: Before I'll build a new tank factory in Germany, we'll of course take a look at it," Armin Papperger said. A jump in European military outlay would mean a jump in production abilities, he said.

"If that happens, we have to double our ammunition capacity," he said. "If that happens, we have to double our vehicle capacity."

Volkswagen, a global titan of auto making, has laid out plans to cease making vehicles at its plants in the German cities of Dresden and Osnaebrueck, part of a drive to save billions of dollars a year in costs as it struggles with lackluster demand.

While there are no concrete plans to see those factories produce other kinds of goods, the group could listen to proposals, VW said.

"We are open to sensible subsequent utilization of the two sites," the company said in a statement.

A group spokesman declined to specify if that would mean making guns and tanks. But moving from civilian to military production isn't a major leap for vehicle factories.

Rheinmetall, which produces ammunition, weapons and other military equipment, said last month that it will repurpose two plants that currently make automobile parts toward mostly military manufacture. French train maker Alstom last month inked a deal to sell a German rail factory to defense consortium KNDS, which plans to use the site to make battle tanks and armored vehicles.

That comes in the context of a major gap in capacity for the scale of new production targeted. An increase in defense spending to 3% of European gross domestic product from around 2% now means equipment made at home would need to increase around 140%, according to analysis from Morgan Stanley.

"Investments will likely be material relative to the size of Europe's defense industry, but small in comparison to total industry in Europe," the bank's analysts said in a note. "Europe's defense industry is essentially at capacity at the moment."

Still, according to European Commission figures, European factories as a whole are operating at less than 80% capacity. And while unemployment stood at a record low in January, more workers may soon be available for the defense industry.

European auto makers and suppliers, including VW and tire makers Michelin and Continental, are planning to downscale operations and cut tens of thousands of jobs. Swedish battery maker Northvolt this week filed for bankruptcy in its home country, pointing to rising capital costs, geopolitical turmoil and lower demand in a sector until recently seen as a guiding light for clean and forward-looking industry in Europe.

European officials last week outlined a plan to raise hundreds of billions of euros for defense, including a joint fund of some 150 billion euros ($163.33 billion) backed by EU debt, as well as a relaxation of strict limits on borrowing at the national level. Germany has said it will exempt military spending from its strict fiscal rules. That could imply an increased military spend of 70 billion euros annually, almost doubling Germany's current defense budget, according to research from BNP Paribas.

Write to Joshua Kirby at joshua.kirby@wsj.com; @joshualeokirby

(END) Dow Jones Newswires

March 13, 2025 06:47 ET (10:47 GMT)

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