DIP – Dithering in Parliament

Defence Investment Plan

In one of his last acts as PM, Sir Keir Starmer’s long-awaited DIP – Defence Investment Plan – has been released in time for the NATO summit in Turkey this week.

Delayed by nearly a year, it has created uncertainty for UK defence contractors and ultimately led to the resignation of John Healey as Defence Secretary.

The DIP will see an additional £15bn of defence expenditure by 2029-30. John Healy had stated the UK’s armed forces require at least £28bn. Under the new plan, defence spending will only rise to 2.7% of GDP by 2030. Many other NATO members have committed to increasing defence spending to 3.5% by 2035. Much of the pressure to ramp up defence spending has been driven by the threat from Putin but also Trump’s ire and wanting European NATO members to ‘step up to the plate.’  Trump will be attending the latest NATO summit, so expect plenty of headlines!

Within the DIP, plans to replace the Royal Navy’s ageing Type 45 destroyers have been cancelled in favour of building six new modern ‘hybrid vessels’ equipped to deploy uncrewed drones in the air, on the surface and under the sea. These are expected to be built and delivered sometime in the 2030s. These will be deployed to counter Russian activity in the North Atlantic and High North to protect critical infrastructure and enhance NATO deterrence.

There is no doubt the face of warfare is changing rapidly, particularly with the use of air and undersea drones in the war in Ukraine as well as damage to underwater infrastructure. The war in the Gulf has also highlighted the need for drone and missile defences, which has seen Trump looking to build America’s ‘Golden Dome’ missile defence system.

If, as expected, Andy Burnham becomes the UK’s new PM next month, he will inherit a reported £4.7bn shortfall to fund the DIP. Cuts to some road-building projects and savings in energy security and net zero are expected to help, together with efficiencies in buying new defence equipment.

Will this be enough?

Whoever is PM will face the same challenge as their predecessors – being constrained by high levels of government borrowing. The new PM faces the poison chalice of welfare spending, even more tax hikes or attempting to borrow more. Financial markets will be watching Andy Burnham like a hawk.

 

What have we been watching?

 

Positive headlines on US-Iran talks, some ‘dovish’ central bankers at the Sintra Forum, a positive week for US equities but another poor one for US semiconductor stocks where AI uncertainties remain.

Brent oil dropped to a 4-month low below $72. This has followed positive headlines on the US-Iran talks. President Trump said that ‘They’ve had very good meetings,’ while Vice President JD Vance said, ‘Negotiators are sitting down with the Iranians, the Qataris, and with others in Doha, talking about some other details here.’ However, what might happen is still unclear. For example, take the thorny issue of passage of the Strait of Hormuz, where media reports suggest several European nations have accepted that shipping passing through would have to pay fees to Iran and Oman. Clearly, we will not be returning to the status quo that prevailed before the conflict began.

New Federal Reserve (Fed) chair Kevin Warsh, speaking at the Sintra Forum, said that inflation risks had come down. This, together with weaker than expected US jobs data, led the market to lower the chance of a rate hike by the Fed in July from 30% to 22%. More significantly, it also saw the size of potential future interest rate hikes from the Fed by December lowered to 0.3%. Against this ‘dovish’ news were media reports that Trump is actively exploring ways to reshape the Fed by removing or replacing key officials.     

 

The head of the European Central Bank (ECB), Christine Lagarde, was also speaking at the Sintra Forum and said that the upside inflation and downside growth risks ‘are probably more balanced than before.’ However, European ‘flash’ June inflation data was softer than expected at 2.8%, as was core CPI at 2.4%. This led markets to expect the ECB to be more ‘dovish’ in the months ahead, with just a 0.2% rate hike possible by December. This pushed European equities to a new record high.

In the UK, it doesn’t look like Andy Burnham will see a challenge, so he should become the new PM before the end of July. That removes the period of uncertainty before the market hears more on policies. He has been, so far, keen to repeat that he will abide by the existing fiscal rules. The likely new chancellor is an important unknown for financial markets.

Finally, while Trump has been trumpeting his success in reopening the Strait of Hormuz, a reminder that bringing Gulf gas and oil production facilities back online will be challenging. A recent explosion at Qatar’s Ras Laffan – the largest LNG (Liquefied Natural Gas) plant, accounting for one-fifth of global production – injured numerous workers as they tried to restart production. The plant had previously sustained heavy damage from Iranian drone and missile attacks.

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