The Bank of England (BoE) may be forced to reconsider its interest rate strategy following the latest escalation in the global trade war, triggered by US president Donald Trump’s announcement of fresh import tariffs.
The UK has been hit with a 10% tariff on all of its goods being brought into the US, which Trump says is a retaliation to UK tariffs on American goods.
With global markets now facing the impact of these new tariffs, the BoE must navigate a delicate decision — continue cutting interest rates, or pause and wait for more clarity on how the situation with tariffs will unfold.
Jason Hollands, managing director at wealth management firm Evelyn Partners, said: "It would be easy to assume that the possible inflationary impact of the tariffs means that interest rates will stay higher for longer. But that might not be the case.
"We can be very sure that this will be bad for the stumbling UK economy at a time when households are struggling with higher taxes and increased bills, but what we don’t know yet is how either the Government or Bank of England will choose to respond.
"The Bank of England will face a dilemma. On the one hand, tariffs are going to lift the prices of some goods and its core remit is to keep a lid on inflation, as close to 2% as possible, which would point to rates staying higher for longer than previously expected.
"On then other, the Bank has taken a wider view of the economy in the last decade or so, taking growth and jobs into account in its monetary policy, particularly when dangerous shocks emerge. As during the pandemic, it will want to support the economy from sinking into recession. It is quite possible that they will regard price spikes related to the implementation of tariffs as a one-off shock and focus more on the risk of economic stagnation.
"It’s not unthinkable that we will actually see interest rates come down more rapidly than expected. Of course any serious hit to UK economic growth could be felt in the jobs market, not just in terms of job insecurity but also in that firms suffering uncertainty – as well as the tax rises already in effect – could restrict wage and salary growth."
Investors are increasing their bets on interest rate cuts by major central banks in an effort to stave off a potential global recession. On Friday, investors piled on more expectations for a rate cut by the BoE, driven by concerns over the damage to trade and economic growth caused by Trump's tariff decision
Futures markets suggest a reduction of approximately 74 basis points (bps) to the BoE's benchmark bank rate by December. This marks an increase from the 54 bps expected just Wednesday, effectively pricing in three quarter-point rate cuts. The likelihood of a rate cut in early May has also risen, now standing at 86%, from a near 50/50 chance just a week ago.
The BoE’s interest rate policy has far-reaching implications for UK households, influencing borrowing costs for mortgages, credit cards, and loans, while also boosting returns for savers.
At present, UK interest rates sit at 4.5%. However, the central bank has been cautious about further cuts, citing growing global trade uncertainty as one of the reasons it refrained from reducing rates last month.
Read more: How and when Trump's tariffs could impact UK inflation and consumer prices
If prices are pushed up for long enough to affect the rate of inflation this could mean interest rates stay higher for longer.
UK inflation has continued to stick above central bank target level of 2%, coming in at 2.8% in year to February, according to data released last week. Meanwhile, economic growth has been sluggish, with data showing a slight dip of 0.1% in January.
BoE governor Andrew Bailey said it was the Bank's job "to make sure that inflation stays low and stable" and that would be "looking very closely" at the impact of tariffs.
Daniel Murray, deputy CIO & global head of research at Zurich-based global private banking group EFG, said: “The risk of a US and global recession has increased directly as a result of the US tariffs, as has the likelihood that inflation stays higher for longer. In turn, the possibility of stagflation makes life very difficult for central banks.”
Economists at the BoE have indicated that the full effect of the tariffs will depend on how other countries respond with their own trade policies, as well as how foreign exchange rates are impacted.
Swati Dhingra, a member of the Bank’s monetary policy committee (MPC), suggested that the inflation impact could be “less than feared”.
She argued that the primary goods the US imports from the UK, such as refined oil, would likely see little price increase due to the new levies. Fellow MPC member Megan Greene also pointed out that tariffs could potentially be “disinflationary,” as businesses in affected countries might shift trade to new international buyers, thereby mitigating the price pressures that could lead to inflation.
Read more: FTSE 100 LIVE: Stocks nosedive after Trump's tariff announcements
Some economists, however, warn that the tariffs could ignite inflationary pressures in the US, which may lead to higher interest rates for a longer period, potentially spilling over to affect the UK economy as well.
Myron Jobson, a senior personal finance analyst at Interactive Investor, explained the broader implications for Britons: “If tariffs contribute to higher inflation, central banks may be forced to tighten monetary policy, which can weigh on bonds and borrowing costs. This could impact everything from mortgage rates to corporate investment, potentially slowing economic growth."
Earlier, in November, the Bank of England had signalled that inflation in the UK was largely under control, with expectations that interest rates would fall below 4% by the end of the year. However, with the latest developments, the BoE, like the US Federal Reserve, is adopting a more cautious approach to its inflation forecasts.
Dan Coatsworth, investment analyst at AJ Bell, said: “There is a strong chance that we see a pause in the current rate cutting cycle, particularly in the US and Europe. Central banks will be worried about rising inflation and that means rates could stay higher for longer.
“Most companies are reluctant to stomach lower profit margins so the end customer is the one who will suffer. They will have to pay higher prices and that means being more selective over what they buy. Some companies will see their sales fall because shoppers either can’t afford it, they’re delaying purchases or they’ve chosen something else.
Read more: Pound rallies as dollar and oil prices drop after Trump's tariff announcement
“A pause in rate cuts is bad news for companies and consumers who are under financial pressure and struggling to pay off their debts. It is also bad news for anyone looking to get on the housing ladder and hoping mortgage rates would come down soon.”
The pound has weakened significantly against the dollar, making imports from the US more expensive. British consumers may find themselves paying more for goods like machinery, transport equipment, and even vital products such as vitamins and antibiotics, as the US remains a key supplier of these items. Higher costs could be passed on to UK consumers, further adding to economic pressures.
CCY - Delayed Quote • USD As of 5:36:34 PM GMT+1. Market Open.
Speaking a day after the tariffs announcement, prime minister Keir Starmer admitted to business leaders at a meeting in Downing Street that “there will be an economic impact from the decisions the US has taken”.
He said he would only strike a deal with Trump’s White House “if it is in our national interest and if it is the right thing to do for the security of working people, protects the pound in their pocket that they have worked hard to earn”.
He added: “I want to be crystal clear: we are prepared, indeed one of the great strengths of this nation is our ability to keep a cool head.”
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