Context. Hubble Space Telescope (HST) spectroscopic transit observations of the temperate sub-Neptune K2-18b were interpreted as the presence of water vapour with potential water clouds. 1D modelling studies also predict the formation of water clouds in K2-18b’s atmosphere in some conditions. However, such models cannot predict the cloud cover, which is driven by atmospheric dynamics and thermal contrasts, and thus neither can they predict the real impact of clouds on spectra.Aims. The main goal of this study is to understand the formation, distribution, and observational consequences of water clouds on K2-18b and other temperate sub-Neptunes.Methods. We simulated the atmospheric dynamics, water cloud formation, and spectra of K2-18b for a H2-dominated atmosphere using a 3D general circulation model. We analysed the impact of atmospheric composition (with metallicity from 1× solar to 1000× solar), concentration of cloud condensation nuclei, and planetary rotation rate.Results. Assuming that K2-18b has a synchronous rotation, we show that the atmospheric circulation in the upper atmosphere essentially corresponds to a symmetric day-to-night circulation with very efficient heat redistribution. This regime preferentially leads to cloud formation at the sub-stellar point or at the terminator. Clouds form at metallicity ≥100× solar with relatively large particles (radius = 30–450 μm). At 100–300× solar metallicity, the cloud fraction at the terminators is small with a limited impact on transit spectra. At 1000× solar metallicity, very thick clouds form at the terminator, greatly flattening the transit spectrum. The cloud distribution appears very sensitive to the concentration of cloud condensation nuclei and to the planetary rotation rate, although the impact on transit spectra is modest in the near-infrared. Fitting HST transit data with our simulated spectra suggests a metallicity of ~100–300× solar, which is consistent with the mass-metallicity trend of giant planets in the Solar System. In addition, we found that the cloud fraction at the terminator can be highly variable in some conditions, leading to a potential variability in transit spectra that is correlated with spectral windows. This effect could be common on cloudy exoplanets and could be detectable with multiple transit observations. Finally, the complex cloud dynamics revealed in this study highlight the inherent 3D nature of clouds shaped by couplings between microphysics, radiation, and atmospheric circulation.