Spending Review: Tough choices unavoidable, says IFS

The Institute for Fiscal Studies (IFS) warns that the UK government faces "unavoidably tough choices" in its upcoming Spending Review due to commitments to limit borrowing and taxation, alongside existing spending plans. While funding increased for several sectors in 2024, future spending growth will slow, potentially requiring cuts to "unprotected" areas outside of health, defense, and schools, particularly if NHS or defense spending increases further. The IFS highlights that the level of health spending, currently planned at £202bn in 2025-2026, is a central trade-off, and achieving productivity improvements in public services will be crucial to mitigate the impact of spending constraints.

Analysis

The UK government is confronted with "unavoidably tough choices" for its upcoming Spending Review on June 11, according to the Institute for Fiscal Studies (IFS), primarily due to Chancellor Rachel Reeves' commitments to cap borrowing and refrain from further tax increases amidst substantial spending demands. While 2024 saw sharp funding increases for sectors like transport, net zero, hospitals, schools, and prisons, this growth trajectory is expected to flatten as spending was significantly "front-loaded" earlier in the parliamentary term. A critical factor will be the allocation to the National Health Service (NHS), projected at £202 billion for 2025-2026 (representing 39% of day-to-day departmental spending); maintaining historical growth rates for health funding would likely necessitate real-terms cuts to "unprotected" public services. This fiscal tightening is further compounded by the government's pledge to elevate military spending to 2.5% of national income by 2027, which the IFS notes will inevitably lead to deeper cuts elsewhere. The challenge is exacerbated by public sector productivity levels that the Office for National Statistics (ONS) reported in 2024 as being below pre-pandemic benchmarks, making it difficult to deliver improved services with constrained budgets. The overall outlook is tinged with a moderately negative sentiment and pessimistic tone, reflecting concerns over potential service reductions, the political tensions highlighted by exchanges between the Chancellor and Shadow Chancellor Mel Stride, and the historical precedent of public sector pay constraints leading to industrial action.

Key Decisions for Investors

• Investors should closely scrutinize the UK's Spending Review on June 11 for specific departmental allocations, as these will reveal the extent of fiscal consolidation and its direct impact on publicly funded sectors.
• Consider re-evaluating exposure to UK companies and sectors heavily reliant on discretionary government spending, particularly those deemed 'unprotected', as they face a heightened risk of budget cuts which could affect revenue streams and growth projections.
• Factor in potential for increased UK market volatility and subdued economic growth resulting from fiscal austerity measures and the challenging path to improving public sector productivity, which may influence investment strategies towards more defensive positioning or necessitate a cautious outlook on UK-centric assets.