No one can say they were not warned: tariff was “the most beautiful word”, Donald Trump said during his election campaign, and Canada, Mexico and China were first on his target list. Yet somehow many very clever people convinced themselves that, because of the sheer economic irrationality of the idea, the US president would not go through with it.

Financial markets must now reckon with this new, erratic reality – with potentially grim knock-on effects for the UK, and Labour’s tax and spending plans.

There is still scope for the sledgehammer of 25% tariffs on Canada and Mexico to be mitigated in the coming days; but as it stands, the free trade area that stretched across North America since Nafta came into force in 1994 is no more.

Whatever economic theory tells us about the benefits of free trade for growth and prosperity, voters in the world’s economic superpower felt sufficiently disillusioned with the status quo to risk smashing it up.

China, which faces an extra 10% on top of existing tariffs, had already been engaged in a simmering trade war with America. But the Canadian and Mexican economies are closely knitted into the US after decades of frictionless trade.

As the Peterson Institute for International Economics said in a recent paper, Mexican exports are worth 40% of the country’s GDP, and about 80% of those go to the US.

Parts can travel back and forth across the border several times in the course of manufacturing a final product. “The imposition of tariffs at each stage of fabrication would be disastrous,” the PIIE said.

It predicted weaker growth and higher inflation across all three countries as a result of the policy – with the proportional impact far worse for Mexico.

For the moment, UK policymakers are watching anxiously from the sidelines, as are their counterparts in the EU. But that may not last for long.

In Davos last month, where there was a dizzy vibe of optimism about Trump 2.0, the trade secretary, Jonathan Reynolds, repeatedly stressed that he did not see the UK as first in the new president’s line of fire.

“The intellectual basis for the kind of advocacy of tariffs comes from arguments on the US side about large US deficits in manufactured goods, which obviously the US has with China and with the EU. We don’t have that between the US and the UK,” he told reporters.

He is right that, so far at least, the UK does not appear to be directly in Trump’s sights: the president has not expressed the same sense of grievance against the UK as he has against the EU, for example, which has “treated us so terribly”.

But even if the UK can avoid being slapped with tariffs directly, the fact that we are a very open economy makes us vulnerable to a significant slowdown in international trade flows – a point Reynolds also made.

The independent Office for Budget Responsibility (OBR) assessed the risks to the UK of rising global geopolitical tensions in its fiscal risks report in 2022.

It suggested an all-out global trade war would depress UK GDP by 5%, though the damage would build up gradually, over more than a decade.

And Trump may yet levy tariffs across the board. He suggested repeatedly throughout his campaign – and again in the speech that was beamed into Davos – that he planned to tax all imports to the US.

“If you don’t make your product in America, which is your prerogative, then very simply, you will have to pay a tariff – differing amounts, but a tariff,” he said.

When the National Institute of Economic and Social Research (Niesr) modelled the impact of a 10% tariff on all US imports recently – with retaliation from trading partners – the outcome for the UK was unsettling.

Niesr suggested sterling could lose 10-15% of its value against the dollar, which is widely expected to strengthen in the event of a trade war. A weaker pound would then feed into higher import prices, and a resurgence of inflation.

While the effects of shifts in global trade patterns can play out over months and even years, as firms and consumers readjust to a new reality, the sharper and more immediate impact for the UK is likely to be felt in government borrowing costs.

There must be a high risk that after the weekend’s drama, with Canada and Mexico hitting back hard against Trump’s tariffs, the markets once again reassess the prospects for US inflation.

If that is their verdict, US bond yields would rise – and as the lurching bond selloff in the early days of 2025 showed, where US Treasuries go, gilts (UK government bonds) tend to follow.

That would push up the cost of borrowing for Rachel Reeves, once again jeopardising the slim margin of error she left herself in the budget, to meet her self-imposed fiscal rules.

If there is indeed a rewed gilts selloff as a result of Trump’s shenanigans, it would be much harder for rightwing commentators to portray it as a devastating personal verdict on the chancellor (though they will certainly try).

But the impact on the OBR’s spreadsheets would be just the same, with a jump in yields potentially putting Reeves on course to bust her fiscal rules.

If she responds with spending cuts, as the Treasury has hinted heavily, Labour’s governing project of fixing public services and delivering the “change” voters demanded, would look even more fragile than it does already.

With Trump already considering his next targets for tariffs, a nerve-shredding few weeks lie ahead on both sides of the Atlantic.