UK Fiscal Policy 2025: Navigating Risks and Opportunities in a High-Inflation, Low-Growth Landscape

The UK's 2025 Spending Review, unveiled by Chancellor Rachel Reeves, has sparked a recalibration of fiscal priorities in a climate of persistent inflation and subdued growth. With a focus on energy security, national defense, and healthcare modernization, the budget allocates £14.2 billion to the Sizewell C nuclear power plant, £29 billion annually to the NHS, and a defense budget targeting 3% of GDP by 2030. However, these ambitious outlays come amid a backdrop of rising public debt (96.4% of GDP) and borrowing costs, as highlighted by the Office for National Statistics (ONS) in August 2025Public sector finances, UK - Office for National Statistics^[1]. This analysis explores the sectoral risks and opportunities for investors, offering asset allocation strategies tailored to a high-inflation, low-growth environment.

Energy: A Dual-Edged Sword

The energy sector emerges as a cornerstone of the 2025 budget, with £14.2 billion earmarked for Sizewell C and £2.5 billion for small modular reactors (SMRs). These investments aim to decarbonize the grid and reduce reliance on volatile global energy marketsUK spending review 2025: Key climate and energy^[2]. For investors, this signals long-term growth potential in clean energy infrastructure, particularly in nuclear and carbon capture, usage, and storage (CCUS) projects like Acorn and Viking clustersUK Spending Review 2025: Key energy and net zero^[3].

However, execution risks loom large. Sizewell C, for instance, has faced delays and cost overruns in the past, raising concerns about project viability. Additionally, the UK's 30-year gilt yield hitting 5.64% in August 2025Public sector finances, UK - Office for National Statistics^[1] suggests investors may demand higher returns for financing such capital-intensive projects. A diversified approach—balancing exposure to energy infrastructure ETFs with hedging against inflation via commodities—could mitigate these risks.

Defense: A Strategic Anchor

Defense spending is set to rise to 2.6% of GDP by 2027, with a long-term goal of 5% by 2035UK spending review 2025: Key climate and energy^[2]. This aligns with NATO's 2025 Summit pledge and reflects growing geopolitical tensions. For investors, defense contractors and cybersecurity firms stand to benefit from increased procurement and R&D funding. The Ministry of Defence's emphasis on resilience measures, such as protecting critical infrastructure, further broadens the scope for technology-driven defense playsUK spending review 2025: Key climate and energy^[2].

Yet, the sector's growth is contingent on sustained fiscal discipline. With the UK's debt servicing costs already straining the budget, any slippage in defense spending could force austerity measures or tax reforms. Investors should prioritize companies with strong balance sheets and recurring revenue streams to weather potential fiscal tightening.

Healthcare: A Defensive Play

The NHS receives a £29 billion annual boost, targeting reduced waiting times and modernized facilitiesSpending Review 2025 (HTML) - GOV.UK^[4]. This funding addresses long-standing systemic issues but may not fully offset inflationary pressures on healthcare costs. For investors, healthcare infrastructure (e.g., hospital construction) and medical technology firms present opportunities. However, the sector's defensive nature—less sensitive to economic cycles—makes it a natural hedge in a low-growth environmentSpending Review 2025 (HTML) - GOV.UK^[4].

Fiscal Risks and Inflationary Pressures

The absence of new tax reforms in the 2025 review, coupled with £120 billion in additional borrowing over the review period, raises concerns about debt sustainabilitySpending Review 2025 (HTML) - GOV.UK^[4]. The ONS reported £18 billion in August 2025 borrowing, the highest in five yearsPublic sector finances, UK - Office for National Statistics^[1], while gilt yields signal investor skepticism. In a high-inflation context, real spending power for both the government and households could erode, exacerbating fiscal imbalances.

Asset Allocation Strategies

1. Overweight Energy and Defense: Allocate 30–40% to energy infrastructure (nuclear, renewables) and defense contractors, leveraging long-term fiscal commitments.
2. Defensive Healthcare Exposure: Allocate 20–25% to healthcare infrastructure and medical tech, balancing growth with stability.
3. Inflation Hedges: Invest 15–20% in commodities (e.g., gold, oil) and Treasury Inflation-Protected Securities (TIPS) to counteract rising prices.
4. Diversified Equities and Bonds: Allocate the remaining 25–30% to broad-market ETFs and high-quality corporate bonds, ensuring liquidity and resilience.

Conclusion

The 2025 UK Spending Review underscores a strategic pivot toward energy, defense, and healthcare, but investors must navigate a fragile fiscal landscape. While sectoral allocations offer compelling growth opportunities, rising debt and inflation demand a disciplined, diversified approach. By prioritizing sectors aligned with government priorities and hedging against macroeconomic risks, investors can position portfolios to thrive in this challenging environment.