Key Takeaways
- The UK government has committed to nearly £300 billion of defense spending by 2030, but uncertainty surrounds how this money will be raised.
- War bond issuance, the first in more than 100 years, is being discussed to fund defense equipment and costs.
- Bond markets will demand that extra defense spending is paired with cuts to day-to-day government spending, says Morningstar’s Michael Diamontopoulos.
With Britain’s military leaders warning that the UK needs to prepare for war with Russia by 2030, the government has just pledged to spend billions more on defense. While policymakers can’t agree on how the money will be raised, a financial product from the First World War may offer a solution.
On June 29, the government revised upward the amount spent on its Defense Investment Plan (DIP) to nearly £300 billion until 2030, a pledge by outgoing prime minister Keir Starmer. His successor, who is likely to be Andy Burnham, will face the challenge of meeting and funding these commitments.
The idea of “war bonds,” government debt issued to fund defense spending, has suddenly resurfaced in the national conversation. While the last iteration was issued in 1917—and only redeemed in 2015—one investment banker describes them as an “elegant solution” for a government with very tight spending constraints. An influential former economist at the Bank of England and new government advisor, Andy Haldane, has just publicly backed war bonds.
They’re one of many options for the next UK prime minister, but have the merit of avoiding increasing direct taxes or increasing overall borrowing, which could lead to a selloff in UK bonds and a spike in yields.
“The UK government is under intense pressure to boost defense spending in a meaningful way. It is unclear to us whether ‘war’ or ‘defense’ bonds will be issued, but we think the mechanism matters less to the market than the overall fiscal strategy,” says Michael Diamontopoulos, associate director for fixed income and currency at Morningstar.
What Is Going on With UK Defense Spending?
One June 11, defense secretary John Healey resigned over the DIP, saying it won’t meet the UK’s need to increase defense spending to 2.7% of gross domestic product by 2030 and NATO’s target of 3.5% of GDP by 2035.
A revised announcement in early July now means the government will spend an additional £15 billion on defense over the next four years. Nevertheless, analysts have pointed out that a significant chunk of the money required to meet this commitment has not been formally budgeted. This leaves a problem for whoever takes over as prime minister and chancellor.
“There’s not a huge amount extra in the DIP in terms of actual cash for projects,” says Saxo UK investor strategist Neil Wilson.
“The £15 billion over four years is just £1.5 billion more than the amount that sparked the resignation of John Healy, the last defense secretary who warned it would lead to defense cuts without much greater additional spend,” he adds.
Some commentators are strongly in favor of issuing debt to fund the commitments.
“The UK finds little room for other immediate sources of funding for what is expected to be higher long-term funding for defense,” says Robert McDowell, a financial services consultant and former investment banker. The issuance of war bonds, he says, would be “the most elegant and proven approach.”
Would the UK Government Issue War Bonds Again?
A financing option usually deployed in times of national military crisis, war bonds offer buyers the opportunity to lend to the government in return for guaranteed interest payments. They operate like other sovereign debt: backed by the UK government, with a fixed coupon and redemption date.
“Unlike the soldier, the investor runs no risk,” declared an advertisement for the UK’s 1917 war loans program. This wasn’t strictly true. The loan’s coupon was subsequently reduced. Some 109 years later, parliamentary interest in this type of instrument is rising again—as though it is an easy solution.
“The UK cannot afford to continue drifting on defense,” reads an early day motion, or written proposal, tabled by the Liberal Democrats in April. It called on the government to establish a “capped and time-limited defense bonds program subject to strong parliamentary oversight” that would raise up to £20 billion over two years for “capital investment and defense equipment.” Though the symbolic motion got just 39 signatures, the party reiterated its plans following Healy’s resignation, calling for a “secure, ring-fenced” bond program.
Experts say the way this is structured could well be the difference between a positive and a negative impact on the UK’s long-jittery gilt markets, particularly given fears that an Andy Burnham-led administration would send gilt yields yet higher.
“Given the fragile state of UK finances, any extra issuance for defense—whether via traditional gilts or thematic bonds—will require a strict rebalancing of the books to reassure bond markets,” Morningstar’s Diamontopoulos says.
“Bond investors will demand that extra defense spending is paired with cuts to day-to-day government consumption spending. To maintain market stability, the government will need to convince investors that the net effect of this fiscal rebalancing has a clear, net-positive growth footprint,” he adds.
Will War Bonds Be Gilts or Savings Bonds?
Fund managers say that issuance depends on whether war bonds are treated as being part of the UK’s existing gilt offering or as a special consumer offering that is handled solely by National Savings & Investments, which itself provides the government’s popular Premium Bonds—which are more of a savings lottery than a fixed-income product—and savings accounts.
“It depends on how they are financed,” says Bryn Jones, head of fixed income at Rathbones. “If they are treated as other gilts, as part of gilt remit, [issuance] will likely have a negative impact. If they are through a defense development bank, or other similar structures, then perhaps they might not have a major impact on gilt markets.”
Who Would Buy War Bonds?
In the First World War, Britain relied at first on institutional investors to buy up its debt before turning to members of the public for help. Participation in the schemes, which reappeared later in the Second World War, was framed as a patriotic duty.
While defense spending is part of the national debate, it’s unlikely the government would achieve a propaganda message as strong as this in 2026. In contrast to the year 1917, Britain is not actively at war against a rival great power.
Other funding solutions could work. The UK government could relax its fiscal rules. It could also raise taxes once more; Andy Burnham said the UK “has room for movement” on tax. The first is anathema to gilt markets. The second would be rejected by voters beleaguered by years of rising inflation and shrinking pay packets. A third and final option—cutting other departmental spending to accommodate spending targets—including the state pension triple lock—looms large.
It’s “difficult” to see how defense spending could rise without other departmental budgets falling, Rathbones’ Jones says. “In this case, it would have a lesser impact on gilt yields as the books would balance out. However, with many areas of the UK public system underfunded, they would need private initiatives to step in and pick up the slack in those areas.”
One group of investors certainly won’t be buying war bonds: ethical investors. That includes Jones, the manager on the £1.8 billion Rathbone Ethical Bond Fund.
“We wouldn’t include them in any of Rathbones’ strategies. This is because our main funds have ethical and sustainable overlays,” he says.
