(Bloomberg) -- The Bank of England is all but assured to cut interest rates by another quarter point this week, but a second US presidential term for Donald Trump has cast new uncertainty over future policy easing in the UK.
Karen Ward, chief market strategist for Europe at JP Morgan Asset Management, said that Trump’s plans to raise tariffs aggressively could trigger a major fiscal response across Europe and China that drives up inflation. Alternatively, Citigroup Inc.’s chief UK economist, Ben Nabarro, argued that UK growth may weaken and trade diversion from China could flood Britain with cheap products and slow price increases.
Investors and economists are widely anticipating the BOE’s Monetary Policy Committee to cut rates to 4.75% on Thursday. Expectations for future policy meetings are little changed from before the US election, with markets pricing in two more cuts by the end of next year and around a 35% chance of a third.
Goldman Sachs cut its 2025 GDP forecast for the UK to 1.4% from 1.6% following the election because “renewed trade tensions weigh materially on growth.” Higher fiscal deficits in Europe as countries invest in defense will push up government borrowing costs while rising geopolitical risks will hurt confidence, the bank said. The overall hit to UK GDP will be 0.4%, compared with 0.5% in the euro area.
Nabarro expects a quarter-point cut on Thursday, with the BOE then treading carefully before shifting to faster cuts later once the implications of US policy become clear. Ward agreed that a rate cut on Thursday was “a done deal, as adding to market volatility by not cutting would not be sensible.”
UK borrowing costs had already jumped on the back of Chancellor of the Exchequer Rachel Reeves’ budget last week, when she unveiled an extra £142 billion ($180 billion) of borrowing over the Parliament, primarily to invest in growth-enhancing capital projects. That increase has wiped out her fiscal headroom, raising the risk of more tax hikes on top of the £40 billion already announced.
Trump has promised a huge policy overhaul for the US, including 10-20% tariffs on goods alongside more aggressive moves against China and Mexico as the centerpiece of a protectionist industrial strategy. He is expected to cut US corporate taxes, deregulate the financial industry and drill for oil. Trump’s demands for greater commitments from North Atlantic Treaty Organization members could require an urgent increase in defense spending across Europe.
While Nabarro said the Trump “inflation impulse is probably negative,” Ward said the consequence of Trump’s plans longer term were likely to mean “more fiscal everywhere” and stoke prices.
“Looking at it through either an economic or political lens, this is not the time to worry about your debt. It will be a time for investment, modernization and strategic security,” Ward said. She warned that the impact would be inflationary and reckons the BOE will stop cutting rates next year once they are around 4.5%. “That seems a respectable place to be in the current mood of uncertainty,” Ward said.
Kallum Pickering, Peel Hunt chief economist, said the UK appeared to be less exposed than the European Union to a reframed US policy. Relative to the EU, “the early market reaction suggests a positive tilt for the UK,” he said. Sterling rose against the euro but fell against the dollar, which surged on the prospect of higher US inflation and fewer rate cuts.
“Trump may not threaten the UK with tariffs, after all the UK already meets its NATO spending commitments,” Pickering said. The UK may also escape tariffs as Trump sees trade as a zero-sum game with only winners and losers. US trade statistics show that America has a trade surplus with the UK, making the US the winner, although British figures show the reverse.
Open Economy
Either way, the UK is unlikely to counter with its own tariffs on the US. Speaking on Sky News’ Sunday Morning with Trevor Phillips at the weekend, Reeves said: “We are an open trading economy. The US is our single biggest trading partner. That’s beneficial for the UK, but it’s also beneficial for the US and so we will work with whoever becomes president and make the case for that free and open trade that we believe in.”
The impact of US tariffs on the UK may be limited, given that trade with the US is largely in services.
“We suspect that the tariffs will only be applied to UK goods exports, not services,” said Alex Kerr, UK economist at Capital Economics. If services are not subject to tariffs “then a weaker pound may boost services exports and as a result UK GDP.”
Against that, Kerr said, Britain could be hit by the indirect fallout from softer global growth and higher inflation, with latter putting upward pressure on UK rates. “The upshot is that we think the impact on UK growth will be very small.”
James Smith, developed markets economist for ING, agreed the UK was less exposed to tariff hikes than the euro area. “The UK certainly isn’t immune from higher tariffs. The US is Britain’s biggest trading partner for goods exports. Clearly though trade, or manufacturing, as a share of GDP is much lower than in the likes of Germany, so in relative terms the UK would be a little less affected.”
Nabarro said the bigger risk was “corporation tax changes and financial deregulation, and the degree to which that incentivizes capital domiciled abroad to return to the US.”
“As the US becomes more competitive, it may start pulling back activity. That would cost growth and jobs” in the UK, he added. “I would not view Trump’s policies as being inflationary for the UK. Overall, Trump’s presidency is not great for activity in the UK.”
Nabarro said fragmentation of the global trading system would also hit Labour’s ambition to pull the UK’s economic growth rate to the top of the Group of Seven advanced nations, of which the US is the largest.
More oil extraction and a deal that ends Russia’s war with Ukraine would reduce energy costs, he said. Tariffs on China could have “a trade diversion effect,” as Chinese electric vehicles are rerouted to the UK.
--With assistance from Irina Anghel.
(Adds Goldman Sachs forecast downgrade for UK)
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