By Kate Holton and William James
LONDON (Reuters) -U.S. President Donald Trump emerged as one of the biggest threats hanging over the British economy on Wednesday, when the country's fiscal watchdog said slow growth and a heavy debt burden made it especially vulnerable to his proposed tariffs.
Finance minister Rachel Reeves delivered a politically unpopular cut to the welfare budget and other reductions in her spending plans, all to keep the economy on track for a key fiscal target that was designed to reassure investors after short-lived former Prime Minister Liz Truss's market meltdown of 2022.
But the country's independent fiscal watchdog said a global trade war could reduce economic output, while a rise in Bank of England interest rates and gilt yield expectations could wipe out her small headroom against that fiscal target.
"If you are going to have 'iron-clad' fiscal rules then leaving yourself next to no headroom against them leaves you at the mercy of events," Paul Johnson, director of the Institute for Fiscal Studies think-tank, said.
Trump has said new reciprocal tariff rates will take effect on April 2 to punish countries that his administration deems to be blocking U.S. exports.
Britain's Office for Budget Responsibility watchdog said higher U.S. import tariffs would dampen UK economic activity beyond any direct impact on the country's exports.
The OBR said U.S. tariffs on its trade partners in general could cut the size of Britain's economy - which is highly exposed to swings in international trade - by as much as 1%.
Reeves and Prime Minister Keir Starmer have already been knocked off course since they were elected last July, promising a period of national renewal.
Rising debt costs and stagnant economic growth have forced them into unpalatable cuts and Reeves has come under heavy pressure from businesses after she used her first budget in October to hike taxes on employers.
But she has stuck to her plan, saying she needed to rebuild the public finances, and reduced payments to the elderly for heating costs before she set out welfare cuts on Wednesday that are expected to affect 3.2 million families.
VULNERABLE TO TRUMP
Her tough line could prove more difficult to maintain if Trump goes through with his threat to impose new tariff rates next week on countries around the world.
The OBR said a 0.6 percentage-point rise in BoE rates and gilt yield expectations across its five-year forecast period would eliminate the buffers that Reeves has built up against her fiscal target, forcing her back to the drawing board.