Day one of President Trump’s state visit to China has left London’s financial district on edge. The so-called special relationship between the UK and the US is being stress-tested by Xi Jinping’s assertive diplomacy, and the markets are not liking the volatility.
Gilt yields have ticked up this morning as investors price in a higher risk premium for UK sovereign debt. The fear is that a Trump-Xi entente could sideline British interests, particularly on trade and defence. Sterling dipped 0.3% against the dollar in early trading, a sign that capital flight may be brewing.
The City’s collective memory is long. We remember when President Obama warned that Brexit would put the UK at the “back of the queue” for trade deals. Now, with Trump cosying up to Xi, that queue looks even longer. The government’s fiscal headroom is already squeezed by high inflation and a stubbornly large deficit. Any erosion of our trade position would force the Chancellor to borrow more, pushing up yields further.
Central bank policy is also in play. The Bank of England is walking a tightrope: inflation is still above target, but a slowdown in global trade could tip the UK into recession. Governor Bailey will be watching Trump’s body language as closely as any market trader. A trade war between the US and China would be a disaster for an open economy like ours.
The bottom line is clear: Britain’s economic sovereignty is only as strong as our ability to forge independent trade relationships. This visit is a reminder that the special relationship has a price tag, and the markets are marking it up daily. Investors should brace for more volatility as the week unfolds. Fiscal responsibility demands that the government maintains a war chest for whatever deal emerges from Beijing. The price of sentimentality is high; the cost of realism is higher still.
