Chancellor Rachel Reeves has signalled she is ready to loosen the purse strings to boost Britain’s armed forces, a move that will further increase pressure on the country’s strained public finances.
After Prime Minister Sir Keir Starmer said that Europe would have to increase defence spending following pressure from US President Donald Trump, Reeves has indicated she would have to rethink her plans.
“The world is obviously changing,” said an ally of Reeves. “Governments have to adapt to a changing world. Rachel takes national security incredibly seriously — a secure economy requires secure defence.”
Britain spends 2.3 per cent of its GDP on defence and Starmer has promised to set out a “pathway” to increasing that to 2.5 per cent, at a cost of between £5bn and £6bn a year — equivalent to around 10 per cent of the core schools budget in England.
Defence chiefs want to go higher to 2.65 per cent — about £10bn more each year than the current budget, a move so far rejected by Downing Street.
Reeves’ colleagues insist she is working “incredibly closely” with Starmer, who will face questions about the UK’s defence budget when he meets Trump in Washington next week.
But what are Reeves’ options?
Change the fiscal rules
Reeves is pinned in by her own borrowing rules, which commit her to balancing the current budget — matching all day-to-day spending with revenues — by 2029-30. Her October Budget set out plans to meet that rule with £9.9bn to spare, just 0.3 per cent of GDP.
That headroom risks being wiped out by poor economic data in the past few months, notably weak growth. If Reeves has to find at least another £5bn for defence, that means she will have to find about £15bn just to get back to square one.
The European Commission is planning to bend its own fiscal rules — the Stability and Growth Pact — to exempt defence spending, allowing cash-strapped EU states to borrow more to build up their militaries.
Could Reeves do the same? Given that she only announced her fiscal rules in October and has repeatedly called them “iron clad”, the markets would take a dim view if they were rewritten now. The chancellor’s team said on Tuesday the rules were “paramount”.
Cut other areas of public spending
Whitehall is braced for a brutal public spending round, culminating in June, with the Treasury asking “unprotected” departments — including the Home Office and Ministry of Justice — to prepare for potential cuts over three years of between 2 per cent and 11 per cent.
The Treasury always sets out eye-watering scenarios for savings at the start of a spending round to force ministers to offer up a menu of cuts, but the pressure to increase defence spending has set nerves jangling.
Given that “unprotected” departments include those responsible for policing, prisons, immigration and local government, Starmer and Reeves face a grim choice in the next few months. “These cuts are totally unachievable,” said one person involved in the talks.
Starmer has promised there will be no return to austerity under a Labour government, yet these are exactly the same departments that were targeted for the steepest cuts under Conservative chancellor George Osborne in the 2010s.
Delay raising defence spending until after next election
Reeves had been seeking to hold defence spending at about 2.3 per cent for as long as possible, according to people briefed on discussions, but Starmer’s recent rhetoric has made any significant delay seem impossible.
He has described a “generational” challenge for Europe, as Trump threatens to withdraw US military support for the continent, and has urged the UK’s neighbours to “step up” and start spending more on defence.
Delaying reaching the target for UK defence spending of 2.5 per cent of GDP beyond the next general election, expected in 2029, would be at odds with this and could provoke criticism from Trump.
Raise taxes
Reeves has not ruled out tax rises in her Spring Statement on the economy on March 26. One option being discussed is a continuation of a freeze on income tax thresholds and allowances beyond 2028, a move considered but discarded by Reeves at her October Budget because it would “hurt working people”.
The Institute for Fiscal Studies think-tank says that freezing income tax thresholds from 2028-29 onwards would bring in roughly £3.5bn-£4bn a year, assuming inflation at 2 per cent.
That would cover most of the cost of raising defence spending to 2.5 per cent of GDP. Reeves could seek to justify this tax U-turn by saying that the world had become a more dangerous place.
Innovative solutions
Several ambitious ideas for new multilateral financing institutions have been pitched to UK officials in recent months.
General Sir Nick Carter, former head of the British military, is among a group who have proposed a “rearmament bank” to tap into Europe’s savings pool, modelled on the European Bank for Reconstruction and Development.
Member states would supply its capital — a suggested pot of €100bn — but pay only 10 per cent up front, with the bank borrowing the rest in the capital markets, helped by a strong credit rating.
Its backers have argued that such a bank, which would be open to the UK and Norway as well as EU states, would be a “quick and efficient way to meet the urgent need for higher defence spending”.
Meanwhile, Rob Murray, founder of the Nato innovation fund, has drawn up proposals for a defence, security and resilience bank that would be open to a wider array of global partners beyond Europe and would aim to leverage broader capital markets to help finance collective security goals.
Both ideas would require enthusiastic backing from international allies to get off the ground.
