The impact of US tariffs on the UK

President Trump’s polices will be disruptive and will distort the world trading system. We know from historic experience, from theory and from forecasting models that there will be a negative impact on the growth of global trade and thus on economic growth from any move towards protectionism.

If the re-industrialisation of the US and re-shoring to the US that President Trump hopes for materialises then this would be a significant positive for the US – but it would take time to feed through.

Financial markets, though, are focusing on what we know is likely – a hit to trade – as opposed to what is possible. Markets are also focused more on the negative impact on growth globally, rather than any price impact, in the US.

The immediate impact on the UK from last night will be relatively small. But, as a large open economy, we will be impacted by the way other countries respond and there could be a significant impact if a global trade war materialises. There are many moving parts and much depends on the response by the UK government, as well as the global policy response. 

The direct impact on the UK will be limited. This is because two-thirds of our exports to the US are in services, which are not being impacted by tariffs, and while UK goods exports are being hit by US tariffs it is at the minimum, new 10% baseline tariff. However, there will clearly be significant hits to some sectors such as cars because of higher specific tariffs of 25%, and also perhaps to pharmaceuticals as the US is a big export market. Previously announced tariffs will also impact steel.

At the same time – and potentially often overlooked – is that some UK firms may find that they are now in a better competitive position selling into the US market as other regions like the EU or countries such as China and many others in south-east Asia have been hit by much higher tariffs. There will be an unclear impact on Northern Ireland, as a consequence of the existing UK-EU trade deal and the fact that the EU will be hit by a far bigger, 20% tariff and that it could also respond with fresh tariffs. 

There is the possibility – perhaps the likelihood – that the UK may yet conduct a free trade deal with the US, which would reduce if not remove fully the direct impact from last night's tariff announcement. This would be a very good outcome for the UK although it would likely involve concessions such as the removal of the digital services tax. Thus, the UK will relatively fare better than others.

The second-round effect on the UK could be sizable, and this will be impacted by how the rest of the world responds to the US. Normally good economics is good politics, but tariffs is a strange area where the politics and economics move in different directions. So, the politics may suggest that a county hit by tariffs should respond with tit-for-tat tariffs. But the economics suggests it is best to avoid such beggar-my-neighbour policies and to not react at all, as tariffs are a tax on imports, and the price is usually paid by the country imposing the tariff, not just by the country on whom the tariff is imposed.

In recent years, there has been a shift from globalisation to fragmentation in the wake of the pandemic. There could now be a move towards protectionism, which would dent global trade and growth. At the very least, it creates significant uncertainty, and this may dampen business confidence. Global growth would be impacted. Generally, though, the impact of tariffs may be disruptive initially before firms and people settle into the new landscape.

The impact on inflation is unclear, as that depends on the behaviour of firms, on competition and how their profit margins are impacted and thus on their pricing strategy. But one would expect some one-off higher impact on US prices, not necessarily a permanent rise in US inflation. Meanwhile, for the UK, the price impact depends on a number of factors. 

There could be some diversion of trade to the UK as exporters priced out of the US market initially seek to offload their goods here – often this is called dumping and countries tend to respond if it happens, not before, to protect their own firms. But in all likelihood this impact would be very small. If the UK does not respond with tariffs – which I think we should not and probably will not do – then the price impact in the UK will be limited. Then there is the currency impact, as this can offset fully any tariff impact. Sterling could benefit from any move to a trade deal with the US but there are many other influences on the currency, including the expected impact on future growth.

The OBR, last week, in their spring forecast provided three scenarios of the impact of tariffs on the UK, depending on their scale and likely response. Based on their forecasts and events last night, there would likely be a hit to growth, and the OBR also projected a small rise in inflation. They did not map exactly the US actions, and the full effect will depend upon how countries respond. In their worst-case scenario, of 20% tariffs across the board, and retaliation, the OBR forecast a hit to medium-term growth of around 0.75% of GDP. 

Because the Chancellor’s fiscal headroom is small, the danger is that all this recreates the scenario we saw last autumn of where there is too much pessimism and a hit to confidence ahead of this year’s Budget. This is on the basis that the fiscal rules would not be met, forcing the Chancellor to take action to meet them, through higher taxes, a squeeze on spending or more borrowing.

Tariffs already exist

Tariffs and non-tariff barriers have been a hallmark of the global trading system. The WTO tariff schedule, for instance, shows the UK's simple average tariff applied by the UK is 5.1%, being 11.1% in agricultural goods and 4.1% on non-agricultural. Also, tariff issues have often come to the fore before last night. For instance, it was only at the end of last year that global markets were focused on the EU's imposition of tariffs on Chinese electric vehicles. 

Trade imbalances have persisted for decades and have not been addressed. As I noted in early December (in this article: "We should have seen Trump's tariffs coming - CapX"), ahead of the 2008 financial crisis much attention was focused on correcting trade imbalances, then seen as the big threat. In June 2006 the IMF hosted the first ever Multilateral Consultation on Global Imbalances. Yet by autumn 2007, the IMF’s World Economic Outlook proclaimed, “risks related to persistent global imbalances remain a concern”.

The strong case has always been for the countries running large surpluses to take corrective action to reduce their surpluses, by boosting domestic demand and imports, allowing their currencies to appreciate, and removing tariffs and barriers to imports. This has not occurred. 

Last night the US moved from targeted measures to full-blown protectionism. The negative from the US actions was the scale and scope of the tariffs, and in particular, their universal range. In contrast, during his first term, President Trump focussed on tariffs being targeted and linked to fair trade. Now they are universal, with a host of emerging economies being hit hard, including many across south-east Asia, plus non-trade issues have impacted US policy, as we see with their approach to Canada and Mexico, for example. All of this could have wider implications, including how countries interact with the US in policy fora and also, in terms of markets, by dampening the dollar’s attraction as a safe-haven

The President focused on reciprocal tariffs, broadly imposing tariffs at half the rate at which they are applied currently to the US, and with a minimum tariff of 10 per cent. President Trump's table of the tariffs imposed on the US may have been subjective, including a range of taxes and currency manipulation as well as tariffs imposed on US goods. For instance, while we see VAT as a sales tax, the US has long seen it in a different way, largely because of how VAT is levied and also because there are VAT rebates, and thus it has been referred to before, and not just recently, as a tax on imports. This adds to the subjective nature of the figures used by the US. 

The US policy focus is on: reindustrialisation and bringing jobs back to the US from overseas (as they believe that globalisation and the movement of production to low-cost countries has led to a hollowing-out of US industry); on raising revenue from tariffs to fund US tax cuts; on reducing the US trade deficit (through making imports less attractive and encouraging firms to invest in the US instead and produce goods from there); forcing other countries to address unfair trade practices.

Finally, the UK Government is right to react calmly, and it makes sense to seek a trade deal with the US. It makes no sense for the UK to seek retaliatory action. Following last week’s spring statement, the OBR forecast 1% growth for this year but the lack of resilience in the UK’s economy leaves it vulnerable to any global fallout from a trade war.

Please note, the value of your investments can go down as well as up.