Defence stocks rally after Starmer vows to ‘go faster’ on spending pledge

Investors piled into defence stocks on Monday after Keir Starmer said the UK needed to “go faster” on defence spending to combat the growing threat from Russia.

The Prime Minister warned that the UK needed to “step up” its defence commitments amid reports that he wants to ramp up the defence budget by tens of billions before the end of the decade. 

“Speculation is mounting that the increase in defence spend will come ahead of the government’s current target,” Danni Hewson, head of financial analysis at AJ Bell said, prompting a rally in the FTSE 100’s defence stocks. 

Shares in Melrose ended the day 3.9 per cent higher, while Babcock gained 3.5 per cent, and BAE Systems rose 3.0 per cent. Rolls Royce shares also rose 1.9 per cent during the day. 

The government has an existing target to increase defence spending to three per cent by 2034, but a report in the BBC suggested this could be accelerated to 2029. 

“We need to step up. That means on defence spending, we need to go faster,” Starmer said on Monday. “We’ve obviously made commitments already in relation to that, but it goes beyond just how much you spend.”

Defence stocks up, fiscal headroom down

Downing Street sources later told reporters that there were no “concrete plans” to accelerate defence spending, but did not deny that conversations had taken place. 

James Smith, a developed markets economist at ING, estimated this would cost an extra £17bn per year on top of the government’s existing budget plans, which could put the government’s fiscal rules at risk.

The government has two fiscal rules, the first is to balance day-to-day spending with tax receipts while the second requires public sector net financial liabilities (PSNFL) – a broader measure of the government’s fiscal health – to be falling within five years. 

According to the Office for Budget Responsibility, the UK has £24bn in headroom against its supplementary target. A substantial increase in defence spending could endanger the second rule, because a greater share of defence is now accounted as capital spending. 

“Higher defence spending would shave a decent chunk off that – and potentially wipe it out entirely if the spending increase is frontloaded,” Smith said. 

Even if it did not entirely erode the government’s headroom, Julian Jessop, an independent economist, noted that markets may still be wary about digesting more government debt. 

“More borrowing is still more borrowing, whatever the purpose, and the markets are already nervous about the outlook for UK debt,” he said. 

Henry Cook, Europe economist at MUFG, said the government would find it difficult to cut spending any further to finance the increase. 

“There seems to be cross-party support for higher defence spending, but finding the fiscal space would certainly be challenging,” he said. “It would be hard to trim anything meaningful from unprotected departmental budgets.”

“The government clearly wanted to end the cycle of fiscal speculation when it increased its headroom at the last Budget, but it’s still not out of the woods,” Cook added.