The pound will remain resilient in a trade war

Trump’s tariffs will harm the world economy but the UK will be one of the least affected developed countries, says Tomasz Wieladek

With President Trump heading back to the White House, US trade policy is anticipated to change fundamentally. We expect the US will impose tariffs on its major trading partners and to some extent retaliation is inevitable. I believe trade restrictions will reduce the growth potential of the world economy, especially outside the US. They will make most countries worse off.

But the expected trade policy will affect countries differently. Their currencies will reflect their relative fortunes. The pound will be one of the most resilient currencies during this period of deglobalisation, because the UK will be one of the least affected developed countries.

The UK is one of the few major economies which has a balanced economic relationship with the US. In some years, the UK records a trade surplus with the US and in others, a deficit. The US is the largest investment destination for UK investors and vice versa. There is also the special geo-political relationship between both countries that is very much alive today. For these reasons, the current US administration may grant the UK an exemption from US tariffs.

US Trade policy is where the UK might finally see a Brexit dividend. First, the UK is now free to enter trade negotiations directly with the US where a free trade agreement would be mutually beneficial. Second, Brexit allows the UK to escape US tariffs which will likely be imposed on trade with the EU. The EU has a large and persistent trade surplus with the US, most of which is the result of Germany’s trade performance. Many EU countries will therefore be subject to US tariffs, only because of their membership in the EU, not the size of their trade imbalances with the US. Not belonging to the EU becomes an economic advantage in this situation.

US Trade policy is where the UK might finally see a Brexit dividend

The UK’s composition of trade will also help it to weather the coming trade negotiations better than most countries. The UK is a world champion in services exports, whether it is education, finance or technology services. But tariffs are only applied to goods, not services. UK exports will likely continue to do well relative to other countries.

The UK’s choice of hard Brexit has led to a significant weakening of the pound against the euro. This will likely change going forward. During the initial negotiation, the focus was mainly on economic relationships, where the EU had the upper hand. But all that has changed with the war in Ukraine and the threat to a weaker US commitment to NATO. The UK’s strengths, a credible nuclear deterrent, superior intelligence services and advanced weapons manufacturing capabilities have now become much more valuable as trade agreement bargaining chips than they were in 2019. This means that the UK government should be able to negotiate a much better trade agreement with the EU going forward. This would support outperformance of the pound against the euro.

Trade wars and geopolitical instability tend to go hand-in-hand. Changes in US foreign policy will likely exacerbate these tensions. The UK hasn’t been invaded since 1066 and has a very long history of protecting property rights. There are few barriers to foreign investment. These are reasons why, in times of large geo-political volatility, the UK tends to become a safe haven. The associated capital flows tend to strengthen the currency.

Services will be less affected by global trade wars

Given the size of the US market, US tariffs will have powerful negative effects on the targeted countries. Services exports, which the UK specialises in, are less likely to be affected by global trade wars. The geopolitical realities we find ourselves in today give the UK a much stronger position in the future EU trade relationship renegotiation. Finally, the UK tends to become a safe-haven currency during times of significant geopolitical uncertainty. All of these factors will mean that the pound will stay resilient and likely strengthen against most other European currencies.

Tomasz Wieladek is chief  is chief European economist at T Rowe Price