There can be little doubt Keir Starmer faces a difficult decision. Not even eight months into his first year, the UK premier must decide whether the UK would benefit more from closer relations with the US or the EU, or a balance between the two, at a time when the relationship between the UK’s closest allies is growing increasingly discordant day by day.
We’ve got to this point through developments outside Starmer’s control – a 47th US president who seems set on imposing sweeping global tariffs and spurning long-held alliances. Now, the path forward for the UK rests on the state of the economy and whether deeper ties with the US or Europe will help get it to a better place.
UK economy: where are we now?
It has been an inauspicious start for the government’s economic growth ambitions. In early February, the Bank of England (BoE) cut its growth forecast for 2025 to 0.75%, compared with the previous forecast of 1.5% in November. At this same meeting, the BoE cut interest rates to 4.5%, its third rate cut since it began easing monetary policy in August. In the short term, this is a positive step for borrowers: some lenders have reduced their fixed-term mortgage rates to below 4% while the interest rate on variable and tracker mortgages has moved closer to the base rate.
However, to continue easing policy and stimulate the much-desired economic growth, the BoE needs to see evidence of steady disinflation, however this is not guaranteed. Annual inflation rose sharply to 3% in January, ahead of expectations for 2.8%, to reach the highest level in nearly a year. Meanwhile, a recent projection from the Monetary Policy Committee showed headline CPI inflation rising more sharply than expected this year, peaking at 3.7% in the third quarter, up from a forecast of 2.75% in November. Looming large here is April, when the hike in National Insurance contributions and increase to the National Living Wage both take effect. Household energy bills could also rise by 5% in April, as lower storage levels of European natural gas have pushed prices up.
The global inflation outlook is uncertain, too. Should President Trump’s tariff threats against both allies and competitors materialise, retaliatory counter-tariffs could spark a global trade war. In this event, progress towards a more accommodative global monetary policy would be harmed.
Closer relations with the US.
While a global trade war would be bad news, the UK’s independence from the EU Customs Union could work in its favour, allowing it to negotiate mutual trade deals and avoid retaliatory tariffs.
One of those bilateral trade deals could be with the US, which is the UK’s biggest trading partner. In the four quarters to September 2024, 17.2% of the UK’s overall trade was with the US. Trump has also indicated he would look favourably on countries with which the US has a trade surplus, a box the UK already ticks. While UK government sources show a trade surplus with the US, meaning total exports are greater than total imports, US figures show a positive trade balance with the UK. This is due, in part, to the US including its export trade with Guernsey, Jersey and the Isle of Man in its figures but the UK omitting this data entirely. So a solid trading foundation already exists, and a UK-US free trade agreement is something both Trump, in his first presidency, and Biden have explored.
The pursuit of a closer UK-US relationship may come at the expense of opportunities in the EU, however. Just this week, in light of Trump’s apparent siding with Russia over Ukraine, German MP Michael Roth declared “the transatlantic relations are over”. If that statement is anything to go by, the EU is unlikely to look favourably on a UK that tries to get the best of both trade worlds.
Closer relations with the EU.
One surefire way of encouraging investment in the UK and stimulating economic growth is by easing trade restrictions put up since Brexit. This could be done by renegotiating the Trade and Cooperation Agreement (TCA) with better terms for both the UK and Europe and reducing the disruption caused by non-tariff barriers like customs checks and border controls. These discourage businesses, particularly small and medium-sized firms, from exporting to Europe.
A closer relationship with Europe is also in line with public opinion, with recent polls suggesting the government should prioritise trade with the EU. More self-interestedly, fostering closer UK-EU ties would also help offset some of the potential damage from US tariffs on the UK or global tariffs that threaten the outlook for inflation and interest rates.
That said, given very recent history, the EU is likely to approach trade talks to pursue its own interests first and foremost, taking a transactional approach. More concerningly, if the UK were to cultivate greater trading ties with the EU, an outsized negative reaction from the US administration could lead to the UK being punished with tariffs on UK goods.
A mixture of both?
A closer relationship with both the US and Europe would increase trade and support economic growth. But events may have already forced Starmer’s hand, with the prime minister declaring the UK is “prepared to play its part” in defending the future of Europe by deploying soldiers to support Ukraine if necessary.
Advanced diversification.
Whichever way the UK turns, having a global tilt to an investment portfolio could give you the opportunity to do more with your money.
In an uncertain world, regional diversification could help to manage risk by balancing out a portfolio’s exposure to country-specific exposure and broadens investment opportunities to include the best of what the world has to offer.
With investing, your capital is at risk. Investments can fluctuate in value and you may get back less than you invest. This material is not a personal recommendation or financial advice and the investments referred to may not be suitable for all investors. Forecasts are not a reliable indicator of future results.
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