Zero to hero? UK narrative switches yet again: Mike Dolan

By Mike Dolan

LONDON (Reuters) -From the Western world's biggest economic car crash to an emerging bridge between trade-warring superpowers, Britain's shifting 2025 narrative is hard to keep up with.

Neither angle will likely turn out to be the 'right' one. But the sudden switch is yet another example of how dangerous it can be for investors to chase the macro zeitgeist in 2025.

This 180-degree turn in the mood surrounding the UK since mid-January is surely welcomed by the Bank of England, which is holding its first policy meeting of 2025 this week.

Hark back just three weeks.

At the time, the central bank appeared to be in a serious bind. 'Gilt' yields had catapulted to multi-decade highs, potentially signaling a full-blown strike among buyers of British government debt. The pound was falling against the dollar. Stagflation fears were festering, as the business community widely panned the new Labour government's tax-and-spend budget. And exchanges between the incoming U.S. administration and the UK government were proving rancorous.

Billionaire Bridgewater founder Ray Dalio told the Financial Times on January 21 that a "debt death spiral" was in the works.

Two weeks later, the UK looks like a different country.

'DEATH SPIRAL' TO 'VERY NICE'

The UK has enjoyed a series of benign inflation reports, rising demand for higher yielding gilts, a rapid sterling bounce and accelerated BoE easing expectations.

Meanwhile, finance minister Rachel Reeves laid out a series of long-term growth spurs this week, reinforcing the idea that the Labour government has converted from an austerian to a 'go-go' growth cheerleader.

The World Economic Forum in Davos last month joined in the love fest.

Some 14% of 5,000 global corporate leaders polled by PwC said they expect Britain to receive more international investment this year than every country except the United States. That's the highest ranking the UK has held in 28 years.

Aided by these calmer waters, markets have moved from pricing just two BoE rate cuts this year - in line with the increasingly cautious Federal Reserve - to at least three.

In turn, the 30-year gilt yield had fallen about 40 basis points from the 27-year high it reached in January to roughly 5.5%, while the pound's trade-weighted index

has reversed nearly all of January's slide.

TRANSATLANTIC BRIDGE?

But the most remarkable turnaround may be the perception of where Britain stands in what could be an unfolding global trade war.

Just one month ago, British Prime Minister Kier Starmer was trading barbs with Tesla boss and Trump adviser Elon Musk. This reinforced fears among investors that the United Kingdom, stuck outside the European Union, could be squeezed mercilessly if the bloc were forced into a trade war with Washington.

That view has now been flipped on its head. Pundits now argue that Britain may be able to surf between the two economic powers, possibly even attracting investment from both as a result of its halfway status.

This is partly because Starmer's charm offensive towards Trump appears to be working. The U.S. president publicly warmed to, in his words, a "very nice" UK prime minister this week.

Starmer is also attending this week's EU summit amid reports that Brussels might be open to Britain joining the so-called Pan Euro Mediterranean convention on tariff-free access to EU markets.

Add to this the fact that the U.S. actually runs a trade surplus with Britain and there is a reasonable hope that London could potentially dodge any tariffs that Washington is drawing up against the EU while simultaneously pursuing more open trade with both.

Taking this scenario to its logical conclusion, there's even chatter the UK could potentially become a 'third country' investment destination for European companies seeking to avoid rising trade barriers between Washington and Brussels.

Will the UK actually become a Transatlantic bridge?

The idea is far neater than what is likely to be a messy reality. And much hinges on global developments far beyond Britain's control.

But just like the changes in the UK debt, growth and interest rate narratives of the past month, this is another massive plot shift, as the UK moves from being an isolated small economy squashed by giant warring economic powers to a potential trade war winner.

The BoE will certainly not want to alter this rosy picture when it convenes this week. But if the past few weeks are any indication, it shouldn't get too comfortable.

The opinions expressed here are those of the author, a columnist for Reuters.

(by Mike Dolan, Editing by William Maclean)