Defense stocks surged after Prime Minister Keir Starmer unveiled a £15 billion military spending boost. But analysts say the rally may not last. The UK's high debt and rising borrowing costs could limit future spending.
On Tuesday, the government said it would raise annual defense spending to £79.1 billion by 2029. That equals 2.7% of the country's economic output. The news pushed the FTSE 350 Aerospace & Defense index up almost 5%.
Several UK defense firms saw their stocks rise. Babcock and Cohort both gained, with Cohort up 3%. Chemring, a specialist in sensors and counter-drone tech, is seen as a likely winner. Analyst Neil Wilson of Saxo Bank said, "We also see Chemring - a specialist in sensors, electronic warfare and counter-drone technology, coming out of this rather well." He also pointed to Rolls-Royce from nuclear power and Tempest engine work, and QinetiQ in AI and autonomous warfare.
Get your free investing masterclass bonus when you join Market Briefs, our free daily newsletter
But valuations are stretched. Dan Coatsworth of AJ Bell said, "Shares in the sector have already priced in a stronger earnings pipeline, with valuations starting to look toppy for many key stocks."
The UK government faces a tight budget. Public debt is high, and borrowing costs are rising. S&P Global Ratings warned that more defense spending could strain government finances and hurt the country's credit rating. Neil Wilson said, "Fiscal constraints and sluggish economic growth means it's not just a simple question of increasing spending." He added that debt markets will punish extra borrowing, and that Starmer ruled out "war bonds" as just extra debt.
Germany's recent termination of a warship contract shows that even countries with greater fiscal flexibility face tough choices. Dan Coatsworth noted that no one knows for certain how long the current rally will persist. "Investors had recently grown tired of the 'more defense spending is coming' messaging given it is old news to the market." He also reminded that project delays and cancellations are common in defense.
The UK's fiscal position leaves little room for error. With public debt exceeding 100% of GDP and borrowing costs at their highest in years, any additional spending could force the government to raise taxes or cut other programs. S&P's warning underscores the delicate balancing act facing the Treasury. Investors should monitor upcoming budget statements for signs of how the government plans to fund its defense commitments without jeopardizing the country's credit rating.
Subscribe to Market Briefs, our free daily newsletter, and claim your bonus investing masterclass
