UK Chancellor is saved by US CPI, but do her numbers stand up to scrutiny?

The Chancellor has delivered her spending review, and a debate is now raging about how she can fulfil her spending commitments without causing the national debt to swell, and UK borrowing levels to surge. The reaction in financial markets has been calm so far, GBP/USD is back above $1.35, while the FTSE 100 and the FTSE 250 are both up slightly. However, UK bonds have been volatile. After initially falling sharply, with bond yields rising, some of the increase has been reversed now that the spending review has passed.

US trade tariffs are not inflationary, yet

The Chancellor was saved by US inflation. The core rate of inflation in the US did not rise as expected and instead remained at a 2.8% annual rate. The monthly rate of CPI was also weaker than expected, it rose by 0.1%. Digging deeper into the US figures, there is no sign that tariffs are having an impact on consumer prices. Core goods prices were lower last month, while service prices rose at a moderate rate. Thus, now that the US has agreed a tariff deal with China, fears about the inflationary impact from President Trump’s trade policy could be overdone.

However, tariffs are still set to be elevated for Chinese imports. The US tariff rate on some Chinese goods will be 55%, according to Trump. There is a baseline 10% duty on Chinese imports, a 20% charge tied to fentanyl trafficking, and 25% from preexisting levies. Trump is framing this deal as a win for the White House; however, some will worry that a 55% tariff rate on China is till hefty, and may  impact US inflation down the line, and the markets are still pricing in just less than 2 rate cuts from the Fed later this year.

Key takeaways from the spending review

Back to the UK. The shadow chancellor highlighted that these plans are unaffordable, and many may agree with him, especially since the UK’s finances are very thin. However, some departments are winners, while others are losers. It is also worth noting that the Chancellor’s plans have not been checked by the Office for Budget Responsibility. Thus, the Autumn budget could look very different from what Rachel Reeves announced.

The key takeaways from the spending review include:

• New prison places.
• £4.5bn for schools
• £39bn for affordable and social housing
• £2bn for AI spending
• £30bn investment in nuclear energy
• Defense spending to rise by 2.6% of GDP, lower than NATO’s preferred rate of 3.5% of GDP.

Overall, this budget is squeezing day-to-day public spending and is focusing on capital investment. Even the NHS’s budget increase is linked to big tech projects rather than day to day spending on the public’s health. Thus, there could be a focus on limiting public sector pay going forward, due to the inflationary impact and the fact that the money is not available.

As always, it is worth interrogating any government promises and this is where the numbers announced by the Chancellor today may not stand up to scrutiny. For example, most of Reeves’ spending pledges encompass the period from 2023/24 to 2028/29, the full parliamentary period. We are already one year into Labour’s term, so some of the spending ‘increases’, that she has announced, have already been spent. Thus, the departments that did see spending increases in this review will not get the amount of money that Reeves promised earlier on Wednesday.

Reeves has a history of U-turns when her policies become unpopular with the public. One spending plan that could be subject to a U-turn is the plan for council tax, which could rise up to 5%. This could be something that upsets voters and is reversed at some stage in the future.

The market impact

Overall, the US CPI report was more important for UK asset prices compared to the spending review. The risk of tax rises in the UK remains alive and well, and we will have to see if this weighs on consumer and business confidence over the summer. Sterling surged after the US CPI report, as the dollar crumbled. UK bonds also recovered, and yields fell, as the market starts to discount the inflationary impact from US tariffs. For now, the markets have absorbed the spending review well, but the big risk for UK bonds will be the autumn budget.