Trade war: From shock to strategy

Trade war snapshot: Where do we stand now?

Since our last publications, Navigating the new trade war: implications on Expected Credit losses and Addressing tail risk in Expected Credit Loss models, tariff developments have moved at unprecedented speed: from universal tariffs announced on ‘Liberation Day’ in early April to a series of mini-deals, delays, and renewed threats across major trading blocs. Here, we focus on the current status quo and the critical milestone dates ahead.

Note:This reflects developments as of 28 July 2025. Given the ongoing volatility in trade negotiations, terms may evolve rapidly.

Key developments and status quo

• The US–UK mini-deal remains in place: 10% tariffs on most goods, 10% (capped) on cars and aerospace exemptions.
• UK steel and aluminium tariffs remain at 25%, with a potential escalation to 50% being threatened.
• The US–EU trade deal agreed on 27 July 2025 establishes a 15% tariff on most EU exports, halving the 30% previously threatened. Steel and aluminium tariffs remain at 50% and are not covered in the reduction.
• US–China negotiations continue, with a critical deadline of 12 August. If no deal is reached, baseline tariffs (currently above 20%) are expected to snap back to 125%, essentially halting bilateral trade.

UK trade exposure: direct impacts and sector sensitivity

With this context, it is important to assess how these trade tensions directly affect banking portfolios. To do this, we consider the data provided by the Office for National Statistics (ONS), noting that the US remains the UK’s largest export destination, accounting for 22.5% of total exports. Goods exports to the US are concentrated in a few high-value categories:

• Cars: £9.0bn (15% of goods) - 10% tariff for first 100k units; 25% thereafter.
• Pharmaceuticals: £6.6bn - 10% universal tariff.
• Generators: £4.6bn - 10% tariff, potentially rising to 25%.
• Scientific instruments: £2.4bn - 10% tariff.
• Aircrafts: £2.2bn - 0% tariff (exempt under mini-deal).

For a full, interactive breakdown of the UK’s goods exports to top trading partners in 2024, visit the UK trade with the United States - Office for National Statistics. Despite the mini-deal with the US, the UK remains subject to a 10% tariff on most of its major goods sectors with its largest trading partner.

Specific industries, particularly smaller firms with limited pricing power, may struggle to absorb these cost pressures. This raises clear red flags for portfolio vulnerability and potential staging shifts under IFRS 9.

As explored in Financial services: Navigating the new trade war, our analysis, based on 100,000 simulations of targeted UK portfolios, demonstrated the high sensitivity of staging shocks to such tariff scenarios (illustratively, a 10% SICR staging shock could raise ECLs by approximately 18%).

Macroeconomic landscape: indirect ECL impacts

On top of the sectoral impacts of the trade war discussed in the previous section, the trade war is also expected to have macro-level impacts:

• On 3 June, the OECD downgraded the UK’s GDP growth forecast to 1.3% in 2025 and 1.0% in 2026, citing specifically the US-imposed tariffs.
• The Bank of England (BoE) has kept interest rates high at 4.25% due to the current inflation rate stagnating at around 3.4%, 1.4% above the 2% target.
• According to the ONS, unemployment rate rose to 4.6%, up 0.2% quarter on quarter, and up 0.7% compared to pre-pandemic levels (December 2019 to February 2020).
• Vacancies fell sharply by 63,000 (-7.9%) to 736,000 between March and May 2025. Vacancies are 59,000 below the January to March 2020 level (pre-pandemic).

Not all is bleak, however, as tariffs may have a disinflationary impact on the UK:

• The brunt of the price increases of tariffs will be borne by American customers, unless the UK further retaliates with tariffs on imports.
• Non-US producers (e.g., most notably Asians, Latin Americans and Canadians) are seeking to offload part of their inventories outside the US and are offering deeper discounts to UK and EU buyers.
• Trader re-direction may lead to increased product supply in the UK, softening price levels.

The above is supported by the publication from the UK government on 25 June, detailing its new trade strategy to protect and boost British business[1]:

• Expanded UK Export Finance (UKEF) to support British businesses entering new markets (Asia, Africa, South America).
• Accelerated Free Trade Agreement (FTA) negotiations, including:
  • A confirmed deal with India, with £25.5bn in projected gains (£15.7bn from UK export growth).
  • An enhanced FTA with Switzerland.
  • Active deals with South Korea, and continued efforts with Canada, Australia, Japan, and New Zealand.

This could influence the BoE to consider rate cuts sooner than anticipated, thereby easing financing conditions and partially mitigating ECL pressure, particularly across retail and SME lending segments.

Still, the broader macro deterioration, slower growth and weaker labour markets maintain upward pressure on Probabilities of Default (PD). Tail risks tied to policy unpredictability (e.g., BRICS tariff escalation) only increase uncertainty.

Strategic risk priorities moving forward

With global trade dynamics changing week by week, static assumptions should not be considered. While some scenarios suggest disinflation and policy easing, others point toward renewed volatility, retaliatory risk, and tail-heavy outcomes. As discussed in Addressing tail risk in Expected Credit Loss models, dynamic scenario analysis becomes essential, not just to model base and adverse cases, but to reflect the widening gap and impacts between trade resolutions and escalation.

We note four key recommendations for finance and risk leaders in the context of credit risk modelling:

1. Sector and geographical sensitivity mapping
   • Evaluate exposure by trade flow sensitivity: Identify counterparties and obligors highly dependent on US demand, especially in sectors facing high or escalating tariffs (e.g., autos, pharma, steel, generators).
   • Granular mapping: Segment exposures by relevant product categories and by geography (e.g., UK exporters to the US, and importers sourcing from Asia/EU under tariff pressure).
2. FX and margin volatility monitoring
   • Portfolios exposed to USD-GBP mismatches, especially in trade finance, should be reviewed under heightened volatility assumptions.
   • FX risk also impacts import cost structures and net margins, indirectly raising default risk in low-margin sectors.
3. Macroeconomic scenario calibration
   • Scenario design: Integrate trade war scenarios into your macroeconomic forecasts, e.g., full reimposition of 2 April tariffs, versus de-escalation or redirection success.
   • Revisit macro assumptions:
     • GDP growth downgraded to 1.3% (2025), 1.0% (2026) per OECD.
     • Labour market loosening: 4.6% unemployment, rising vacancies-to-applicant ratio.
4. Overlay and governance adjustments
   • Apply management overlays for tariff-sensitive portfolios at the parameter level (PD, LGD, EAD), not just as a blanket post-model adjustment to total ECL.
   • Base overlays on sound, transparent methodologies, such as scenario testing and Monte Carlo simulations.
   • Ensure overlays reflect impact on staging as well as ECL, in line with IFRS 9 requirements and supervisory warnings about underestimating SICR effects from novel risks.

As we move into August, attention will turn to the next major milestone deadlines:

• 1 August: expiry of tariff pauses for 21 countries, including potential reactivation of 25–40% tariffs.
• 12 August: deadline for the US–China deal, with a possible snapback to 125% tariffs.

These dates are more than just footnotes on a trade calendar: they represent real tipping points for provisioning assumptions, sector risk ratings, and market volatility.

Whether the coming weeks bring de-escalation or deeper fragmentation, one thing is clear: your ECL model must be ready for both outcomes, through updated overlays, adaptive scenario weights, and clear traceability in your governance files.

Sources 

[1] New Trade Strategy to protect and boost British business - GOV.UK