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Rachel Reeves’ room for manoeuvre on public finances was thrown into stark relief on Thursday after Donald Trump announced 25 per cent tariffs on foreign-made cars.
Within hours of the UK chancellor announcing her Spring Statement, the prospect of an escalating trade war posed a new threat to the £9.9bn of headroom she had given herself against the many risks facing the economy.
Richard Hughes, head of the independent Office for Budget Responsibility, warned that a full-blown global trade war could eliminate that headroom, while some economists said the chancellor could be forced to raise taxes in her autumn Budget.
“This represents the crystallisation of one of the risks that we highlighted around our central forecast,” Hughes said on Thursday.
Reeves said she hoped the American president could be persuaded to exempt Britain from the tariffs before they were introduced on April 2, saying: “We are in intense negotiations with our US counterparts on cars, steel and every other type of tariff.”
She said the US and UK had a broadly balanced trade relationship and also suggested that Britain would not immediately retaliate. “We don’t want to get into a trade war,” she told the BBC.
Hughes said that, in a worst-case scenario where the US levied additional 20 percentage point tariffs across the world and the UK retaliated, “we would lose about 1 per cent of GDP at its peak”.
He said that would weigh heavily on growth next year — which the OBR has forecast will hit 1.9 per cent — and would lower growth in the medium term by 0.75 per cent.
“That kind of hit to the economy would also be a hit to revenues,” he said. “It would have implications for expenditure because of its impact on inflation.
“That kind of shock would be enough to wipe out the £10bn of headroom Rachel Reeves has set aside.”
Hughes warned that Reeves’ headroom was “a tiny fraction of the array of risks and shocks that could hit the UK economy in the next five years”. He added: “It’s a very small margin to set aside.”
He said that on top of tariffs there were risks to the UK’s domestic productivity outlook, a warning to the chancellor that the OBR might re-evaluate its consistently optimistic assessment of Britain’s growth potential.
“There’s a lot of uncertainty about recent figures and what they mean for UK growth and output for workers,” he said. “If growth were just 0.1 per cent less per year over the next five years, that would be enough to wipe out that headroom.”
The US is the second-largest export destination for UK-made cars, accounting for 17 per cent of the industry’s exports after the EU, which accounts for 54 per cent, according to the Society of Motor Manufacturers and Traders.
The UK’s main goods export to the US is machinery and transport equipment, which in 2023 comprised £27.2bn of its sales to America, or about 45 per cent of the total of goods exported.
Within this, car exports were worth £6.4bn, according to the Office for National Statistics.
While the UK exported £60.4bn of goods to the US in 2023, it sold services of £126.3bn in the same year, according to the most recent figures available from the ONS.
UK luxury car brands such as Jaguar Land Rover, Aston Martin and Bentley would be hit hard by the tariffs since they do not produce any cars in the US.
Ian Henry, an automotive production expert who runs the AutoAnalysis consultancy, said some luxury brands such as Rolls-Royce and Bentley may have more flexibility to absorb the higher tariffs by cutting margins at dealers or by trying to reduce the cost when vehicles arrive in the US.
“For UK car exporters this is a very challenging development,” said Tomasz Wieladek, economist at T. Rowe Price. “Some of the very high-end producers might be able to pass the cost of tariffs on to consumers, because their customers are price insensitive. For all other UK automakers, this policy will severely restrict market access.”
While building a new plant in the US would take years, Henry suggested brands such as JLR and BMW-owned Mini could consider assembling vehicles in the US using “completely knocked-down” components.
But that option is also likely to be difficult since the Trump administration has said the 25 per cent tariffs will also apply to parts sourced from outside the US.
In her Spring Statement, Reeves announced a series of spending cuts, including a controversial £4.8bn reduction in welfare, to fill a £14bn hole in the public finances.
She ended the day with £9.9bn of headroom against her fiscal rule, exactly the same as she left herself in her October Budget, but very small by historical standards.
Many economists think she could be forced to raise taxes this year to put the public finances on a more stable footing and to “shockproof” them against the kind of Trump-related initiatives seen overnight.
Reeves’ “ironclad” fiscal rule means she must balance current spending with tax receipts by the end of the forecast period in 2029-30.
