How do we manage the financial risks resulting from war?

Governments are prioritising protecting their nations against an insecure geopolitical backdrop. The rivalry between the US and China, concerns about access to essential products, and vulnerabilities in global supply chains, are all interlinked. These factors are of major concern to world leaders. Now, making economies as efficient as possible is becoming less important than making them more secure.

For investors, this shift could make certain sectors look more important, beyond just aerospace and defence. NATO’s Hague Defence Investment Plan frames security-related investment as more than just military spending – rather, it is spending to “protect our critical infrastructure, defend our networks, ensure our civil preparedness and resilience, unleash innovation, and strengthen our defence industrial base.” As such, Industrials, rare-earth materials, artificial intelligence, and leading-edge semiconductor producers are all clear beneficiaries.

A weaker outlook for the UK 

The UK economy started this year strongly, posting 0.7% growth in the first quarter which made it the best-performing G7 country. But much of that growth came from temporary factors, like businesses rushing to export goods and people bringing forward house purchases before expected changes to stamp duty and US trade tariffs. As these one-off boosts faded, signs of weakness appeared, with the economy shrinking by 0.3% in April and both the manufacturing and services sectors struggling. Recent business surveys also show weak demand for new orders and cautious hiring plans. On top of that, uncertainty over US trade policies is still making businesses nervous. The recent UK-US trade agreement has brought some short-term relief, especially for beleaguered car manufacturers, by laying the groundwork for future trade ties between the two countries. Even so, the Bank of England is estimating weak growth of just 0.1% for the second quarter of 2025.

Job market cools

The UK job market is also showing clear signs of cooling. The unemployment rate rose to 4.6% between February and April, and job vacancies fell to their lowest level since mid-2021. Fewer new jobs are being created, and pay growth has slowed to around 5.3%, with further declines expected. Higher employer costs from National Insurance (NI) increases are also weighing on the jobs market. If this trend continues, it could hurt household spending.

Inflation remains higher than the Bank of England’s 2% target, with annual inflation at 3.4% in May, but underlying trends suggest price pressures are easing. Core inflation, which excludes volatile items like energy, fell to 3.5%, and services inflation dropped to 4.7% in May. Policies such as the employers’ NI hike are likely to keep overall inflation elevated in the short term. But, with falling demand and a weaker job market, inflation could ease further unless we see a sustained spike in energy prices.

More aggressive interest rate cuts?

The Bank of England kept interest rates at 4.25% in June and is expected to cut rates twice, by 0.25% each time, later this year. However, with the economy looking fragile, the job market softening, and uncertainty over US trade, there’s a real chance policymakers could cut rates faster or more aggressively than markets currently expect. The Bank will likely ignore temporary inflationary pressures to make its next policy decision, due on 7 August. Upcoming economic data will be critical in determining its next move.

US trade policy vs global manufacturing

Uncertainty around US trade policy is making the global economic outlook more unpredictable. Key indicators look more volatile, which in turn makes life harder for central banks trying to balance two tricky tasks - keeping inflation under control while also supporting growth.

Recent data shows that worries over tariffs have caused people and businesses to bring forward spending, making it harder to judge the true state of the economy. For example, US retail sales jumped by 1.5% in March 2025, largely because people rushed to buy cars and other expensive goods before tariffs potentially pushed prices up. Car sales surged nearly 12% that month, but then fell 3.5% in May as demand returned to normal.

A tough time for carmakers 

The car industry has been hit particularly hard by new US tariffs and by the fact that demand for big-ticket items tends to be seasonal. In contrast, sales of other goods have been steadier, although they also dipped slightly in May.

In Japan, factory output grew slightly by 0.5% in May - well below the 3% expected - as exports to the US dropped 11% compared to a year earlier. This was driven by a sharp 25% fall in car exports and a 19% drop in car parts.

The UK’s car industry has also struggled, with vehicle production down nearly a third over the year to May, and car exports to the US falling sharply. However, a new UK-US trade deal which came in at the end of June will cut US tariffs on UK car exports from 27.5% to 10% for up to 100,000 vehicles a year - roughly the number the UK typically exports - giving some relief to British carmakers.

China’s exports to the US also dropped more than 30% in May compared to a year earlier, but overall Chinese exports grew as the country shipped more goods to other markets to avoid US tariffs.

In general, US consumer-facing companies - including retailers, car makers, clothing brands, and luxury goods firms - are especially exposed to economic uncertainty and trade policy changes. These companies rely heavily on global supply chains, making them vulnerable to tariffs. They also often have little ability to raise prices to offset higher costs, which squeezes their profit margins. With US consumer confidence weak, spending on non-essential items could fall further in the months ahead.


Information correct as of 3rd July 2025