TBH I made a right mess of this the first time I did it so hopefully someone else who really knows will be along in a minute with better advice!
I did the axle fittings up much too tight as I didn't really understand what they were doing.
Also I now realise I shouldn't have touched the fixings on on the drive side of the axle.
When I put the axle fittings back on finally I got them as close to the rest of the wheel assembly as I could without it affecting the wheel rotating. So to answer your question:
JimblyWotsits wrote: Presumably it needs to move freely for the wheel to spin, but should still be seated tightly against the bearing itself? Otherwise water etc could get in to the bearing?
Yes I think so. That's what I did anyway.