[MARKET ANALYSIS] Fiscal implications of Burnham's intended cost of living measures/defence spending

UK PM Burnham appointed his cabinet ministers throughout Monday afternoon. The highlight was a surprise appointment of John Healey as Chancellor, the former defence minister who previously served at the Treasury under Gordon Brown. Home Secretary Mahmood was almost certain to be Chancellor, with most outlets reporting she was set for the job. GBP was essentially unchanged after the announcement, as Healey is seen as a “pair of steady hands” similar to Mahmood. A UK official told POLITICO the PM chose Healey because they “share the same outlook". 

Fiscal Rules 

• GBP and Gilts were offered towards the close on Monday after Burnham said he would use “any flexibility” within the fiscal rules (which top advisor Lord Jim O’Neill and Minister Torsten Bell have advocated). Lloyds Bank notes the definition of the second fiscal rule opens the possibility of  ‘potential fiscal illusions’ - allowing for extra spending which doesn’t add to the ‘PSNFL’ debt measure but would have implications for gilt issuance.

Defence 

• Healey resigned as Defence Minister after clashes with the Treasury on funding. He argued that the proposed funding settlement fell “well short” of what was needed, with the DIP, proposed by Reeves/Starmer, indicating spending of c. 2.7% of GDP by 2030, below Healey’s demand of 3.0%. Based on existing OBR forecasts, Healey’s spending target implies an extra GBP 10bln/year. This would be on top of the GBP 1.2bln/year (GBP 4.7bln total) unfunded under the Dan Jarvis/Starmer DIP. Babcock +7% (seen as the primary beneficiary), BAE +3%, Rolls-Royce +2%, Qinetiq +4%.

VAT cut on energy bills 

• Burnham and Healey this morning announced they would remove VAT on electricity bills from October 1st, funded by cancellation of the Digital ID programme. The Rate will be cut from 5%, as part of measures the newly appointed PM had touted in remarks on Monday. The cut would cost 850mln in 2026-27 and shave 0.1ppt off CPI inflation (according to the release). The Times reported last night that incoming cost of living measures are "fully funded". The Digital ID programme was expected to cost GBP 1.8bln over three years; however, in November, the OBR said that figure for the ID scheme was “unfunded” as it was based on savings from departmental budgets that had not yet been identified. Government departments have reportedly been working on realising these savings, with sources telling POLITICO they will once again be reprioritised to fund the new VAT measures. As such, a number of MPs (incl. Starmer aides and the Shadow Chancellor) have opined the cuts are unfunded.

Looking Ahead 

• Focus on further cost-of-living measures to be announced. Touted measures include a slash in business rates for the hospitality sector by 20% - which could be announced within days and funded by warehouse taxes. Alongside this, Burnham also spoke of raising the personal tax allowance.