Opinion As Trump’s tariff policies play out, the US Fed takes a longer pause

Actions of central banks around the world are increasingly diverging from those of the US Federal Reserve. In April, the European Central Bank had cut interest rates as it noted that “the outlook for growth has deteriorated owing to rising trade tensions”. A few days prior to that, the RBI’s monetary policy committee had lowered rates in India. And on Thursday, the Bank of England also reduced interest rates. In comparison, in its May meeting, the US Fed has kept rates unchanged for the third straight time, maintaining the federal funds rate in the 4.25-4.5 per cent range, as it noted that the risks of higher unemployment and inflation have risen.

The implications of US President Donald Trump’s tariffs, which are “significantly larger than anticipated”, are clear. As Fed Chairman Jerome Powell noted, “if the large increases in tariffs announced are sustained, they are likely to generate a rise in inflation, a slowdown in economic growth and an increase in unemployment”. But, at the current juncture, the Fed’s next steps are difficult to predict. In fact, Powell has also acknowledged that, saying that “it’s really not at all clear what it is we should do”. US GDP contracted by 0.3 per cent at an annualised rate in the first quarter of 2025 as imports surged by 41.3 per cent with consumers and firms trying to get ahead of Trump’s tariffs. Inflation, though, has remained in the 2.5 per cent to 3 per cent range for several months now — the personal consumption expenditures price index was at 2.3 per cent in March, down from 2.7 per cent in February. The labour market also remains healthy. As per the US Bureau of Labor, non-farm payroll rose by 1,77,000 in April, surpassing expectations. The unemployment rate remained unchanged at 4.2 per cent. Powell has also noted that the US economy appeared healthy, and has said that (the effect) “just hasn’t shown up yet”. This provides the central bank the space to wait.

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Higher tariffs will derail the economic momentum. There are already some indications of a souring of sentiment. Much will now depend on if, how quickly and to what extent trade deals are struck and tariffs are rolled back. On Thursday, Trump announced on a social media platform that the US and UK had reached an agreement on a trade deal, with “many other deals, which are in serious stages of negotiation, to follow”. However, Trump is also reported to have said that he would not consider lowering tariffs on China ahead of talks — US and Chinese officials are slated to meet this week. In the weeks and months ahead, the incoming data will reveal the full extent of the impact of tariffs on the US economy.