2 June 2025: Reeves faces budget conundrum in spending review

The Government’s commitment to increase defence spending to 3% of GDP by the end of the next Parliament means that Rachel Reeves' spending review will be less than popular with several “unprotected” departments.

The Institute for Fiscal Studies predicts that the upcoming spending review will be dominated by defence and the NHS funding, with other priorities receiving limited funding. Junior Doctors and nurses have become the most militant of all public service workers, despite both having received well above inflation pay increases since Keir Starmer became Prime Minister.

The Local Government Association is calling for a “significant and sustained” boost to council funding to avoid devastating consequences for vital services. Meanwhile, the Lib Dems and Green Party are urging the Government to invest in social care and negotiate the country’s re-entry into the EU customs union before making further cuts to already stretched budgets.

Spending commitments on defence mean it is “impossible” for the Chancellor to invest in economic growth, public services and net-zero policies when she allocates money for the next three years, leading economists have warned.

Later this morning, Reeves will announce her new defence strategy, which will essentially be the official confirmation of much additional funding the Government is committing to the army, navy and air force.

Defence Secretary John Healy went further as he said there was “no doubt” the UK would meet its target to raise the level to 3% by 2034.

At the spending review, the government faces some unavoidably tough choices, particularly since, after turning on the spending taps last autumn, the flow of additional funding is now set to slow to more of a trickle.

On capital spending, government investment is set to be sustained at historically high levels in the coming years. Still, most of the increase happened last year and this year, and it looks as if all the remaining increase in funding over this parliament has already been allocated to defence.

“Simultaneously prioritising additional investments in public services, net-zero and growth-friendly areas within this envelope will be impossible.

It would be unkind to say that Independent MPC member Catherine Mann has flip-flopped between hawkish and dovish attitudes to monetary policy recently, as she first voted to cut rates by fifty basis points when no change was made and then voted for no change at the last meeting at which rates were cut by twenty-five basis points.

In actuality, she has been the only member of the committee who has been able to see through the fog of data and consider the wider picture of what is happening on the ground. Her attitude to monetary policy will make the speech she is making later this morning all the more interesting to the financial markets.

The market has seen its “uncertainty level” increase again as President Trump has announced a doubling of the tariff on steel imports, as his administration prepares its appeal of the court ruling that tariffs on other imports overstep his authority.

The pound rallied above the 1.35 level earlier this morning in Asian trade but has gradually drifted back to around 1.3475 as sellers have emerged.

Former US President Bill Clinton criticised Donald Trump’s defiance of legal norms and called for a renewed national focus on common ground, warning against political intimidation and democratic erosion.

Clinton described Trump’s governing style as unprecedented in modern US history. “We’ve never seen anything like this before in my lifetime, somebody that says, ‘Whatever I want should be the law of the land. It’s my way or the highway,” he told CBS. “And most Americans don’t agree with that.”

Clinton also suggested Trump’s aggressive rhetoric and disregard for norms may have diminished his popularity. “I like to think that he’s paid a price for this, you know, name-calling and throwing his weight around, I think it’s made him less popular.

Trump has reacted poorly to the news that a court has ruled his imposition of tariffs on the bulk of U.S. imports illegal. The majority of the public had assumed that the President had the right to decide on tariffs on U.S. imports, but it turns out that he had been invoking emergency powers which were not designed for this purpose. It is hard to describe something that, by Trump’s admission, has been happening for decades, has suddenly become a national emergency.

Also, President Donald Trump’s attempts to punish law firms that employed his perceived foes or handled cases he disliked have been bitingly rejected by courts, with three federal judges lambasting them as retaliatory and unconstitutional.

In a further blow to the legality of his seemingly all-powerful attitude to the law, the President has been brought to book. Trump has lashed out at multiple firms in his second term, moving to strip their government contracts, suspend employees’ security clearances and block their access to federal buildings and officials.

Four firms have sued, and judges have said in rulings that the President again overstepped his authority, punished the firms for speech that is protected by the First Amendment and wielded executive power to pressure them and others into falling in line.

“The order shouts through a bullhorn: If you take on causes disfavoured by President Trump, you will be punished!” U.S. District Judge Richard J. Leon wrote in rejecting sanctions on the one Washington law firm.

It is doubtful that Trump is physically able to draw back on his rhetoric, which is something that his supporters love him for, but could seriously hamper his administration going forward.

Later this week, traders will be able to look at solid data that actually has a bearing on the way the economy is acting currently.

Data for manufacturing output is due for release later today. With a move back above the 50 level, which differentiates between expansion and contraction, a real possibility exists. The first cab off the block may be seen as positive.

Then, from Wednesday, various numbers for employment, both in the public and private sectors, will be released, culminating in the May employment report on Friday.

The current prediction is for 130k new jobs to have been created in May. This will neither particularly excite nor disappoint traders and investors, and the effect on the dollar will be negligible. The dollar index is attracting selling interest on any approach towards the 100 level currently, and it closed at 99.45 on Friday evening.

It may be a little coy to describe this week as a watershed for ECB monetary policy, since it has cut interest rates for eight consecutive meetings.

That having been said, the latest inflation data is due for release tomorrow and the Central Bank’s rate-setting Governing Council is set to meet on Wednesday and Thursday, with a decision on whether rates will be cut again due for publication on Thursday lunchtime, followed by a speech and press conference by the ECB President Christine Lagarde.

It may well be that Ms. Lagarde is a lame duck president by then, if rumours of her considering leaving her post before her term expires to take over at the World Economic Forum are true.

Lagarde has been a disappointment as President of the ECB. She has not had the fortitude for the battle that her predecessor, Mario Draghi, had, particularly as she considers herself more of a diplomat than a technocrat.

There is no job description in existence for the job, and each incumbent, since the first, Wim Duisenberg, has made it up as they went along, with varying degrees of success.

Eurozone inflation has been helped by the rise in the value of the Euro since early April. It is predicted that last month's rate of 2.2% will again be improved upon, with the headline rate expected to reach the ECB’s target of 2%.

The most important question that the market will be asking is “Will the ECB see fit to cut rates again if inflation has now reached its target?”

The more hawkish members of the Governing Council will say that the full effect of previous cuts has not yet been fully priced into the economy, and they will be wary of a significant undershoot. Meanwhile, the more dovish among the Eurozone Central Bankers will believe that they have committed to bringing rates down to 2%, which will be the result of a cut this week.

U.S. President Donald Trump’s tariff regime has sparked volatility in American assets, and European officials are making no secret of wanting the euro to seize upon wavering confidence in the U.S. dollar.

The dollar is by far the world’s most commonly held reserve currency, accounting for almost 60% of global foreign exchange reserves and playing an important role in the trade of assets like oil and gold. It also acts as a peg for currencies, including the Hong Kong dollar and the Saudi Riyal.

In second place, trailing far behind the greenback, is the euro, which makes up around 20% of international FX reserves. It would be a shift of seismic proportions if the Euro managed to move from 20% to 30% with a consequential fall in dollar holdings from 60% to 50%. It may be felt that 50% of holdings in dollars, with 50% shared among the other major currencies, would be more equitable, but it would have a significant effect on the stability of the financial markets. That is according to the Federal Reserve, but then they would say that.

The euro is trading between 1.13 and 1.14 currently, while the market waits for further announcements from President Trump and the European Commission considers its reaction to the imposition of tariffs on its exports to the U.S.

Have a great day!