UK Spending Review 2025: Navigating Fiscal Crossroads for Asymmetric Returns

The UK's June 2025 Spending Review marks a pivotal moment in fiscal history, as constrained budgets force stark trade-offs between healthcare, defense, and other public services. This review, the first since 2021 and the first post-pandemic era, is set to reshape the UK's economic landscape. For investors, this is a high-stakes environment rife with asymmetric opportunities in equities and risks in credit markets. The key lies in understanding where capital will flow—and where austerity will bite hardest.

The Fiscal Tightrope: Healthcare and Defense Win, Others Lose

The government's priority is clear: healthcare and defense will dominate spending allocations. Healthcare's £202 billion day-to-day budget (39% of total departmental spending) is under pressure to grow at rates that could force cuts elsewhere. Defense's pledge to reach 2.5% of GDP by 2027—and potentially 3% by 2034—ensures it becomes the largest fiscal beneficiary. Meanwhile, sectors like policing, social housing, and energy efficiency face austerity-driven cuts.

Equity Opportunities: Defense and Healthcare Suppliers to Benefit

The winners are healthcare suppliers and defense contractors.

Healthcare: A Sustained Tailwind

NHS reforms, including the £3.25 billion Transformation Fund for digitization and AI-driven efficiency, will boost demand for medical technology, diagnostics, and infrastructure. Companies like Smith & Nephew (medical devices) and Spirax Sarco (hospital HVAC systems) are poised to gain. The NHS's workforce expansion plans also favor staffing agencies and training firms.

Defense: A Boom for Contractors

Defense's 2.5% GDP target implies £6.4 billion in added spending by 2027. Prime contractors like BAE Systems (aircraft, cybersecurity) and Rolls-Royce (jet engines, nuclear submarines) stand to benefit. The Strategic Defence Review and Defence Industrial Strategy will further amplify demand for advanced systems.

Unprotected Sectors: Avoid "Value Traps" in Public Services

The losers include utilities, policing, and social housing—sectors facing explicit cuts or constrained funding.

• Utilities and Infrastructure: While infrastructure capital spending is growing (1.3% annually), non-defense projects like energy efficiency and public transport are underfunded. National Grid and WSP may struggle with delayed projects, while smaller firms in climate adaptation risk margin pressure.
  

• Policing and Local Government: The Metropolitan Police's £260 million shortfall and the projected £8 billion local government funding gap by 2028–29 signal systemic underfunding. This weakens operational resilience, making equities in public services (e.g., Serco, Mitie) vulnerable to earnings downgrades.

Credit Risks: Local Authority Bonds Are a Value Trap

High-yield local authority bonds, often marketed as “value plays,” are now fraught with risk. Cuts to day-to-day budgets and rising operational costs (e.g., pensions, energy) will strain local governments' balance sheets. The OBR's growth downgrades and the Treasury's fiscal rigidity further amplify credit risks.

• Rating Downgrades Ahead: Look for agencies like Moody's or S&P to downgrade issuers with high debt/GDP ratios.

• Yield Premiums Misleading: While yields on local bonds are higher than gilts, the risk of defaults or forced austerity-driven service cuts makes them poor long-term bets.

Investment Strategy: Overweight Defense/Healthcare, Underweight Unprotected Sectors

1. Equities:
2. Overweight: Defense (BAE Systems, Rolls-Royce) and healthcare (Smith & Nephew, Spirax Sarco).

3. Underweight: Utilities (National Grid), public services (Serco), and housing-related stocks (Taylor Wimpey).

4. Bonds:

5. Avoid high-yield local authority bonds. Instead, focus on investment-grade gilts or corporate bonds tied to defense/healthcare firms.

Conclusion: Act Now—or Be Left Behind

The Spending Review's fiscal crossroads create a clear divide: capital will flow to healthcare and defense, while austerity strangles unprotected sectors. Investors who act decisively—overweighting equities in growth sectors and avoiding credit risks in local government debt—will secure asymmetric returns. Those clinging to “value traps” in austerity-hit areas may find themselves on the wrong side of history.

The clock is ticking. The UK's fiscal reset is here—and the winners and losers are already clear.