US President Donald Trump is achieving his desire for a global interest rate cut, but not in the US, where a strong economy and uncertainty about his own policies have created conditions for the Federal Reserve to break away from the policies of its central bank counterparts.
The European Central Bank cut rates on Thursday, the Bank of Canada did the same on Wednesday, and the Bank of England is likely to reduce them next week. These moves, coupled with the fact that the Fed is holding rates steady, may strengthen the dollar and further complicate Trump’s trade goals, making imports cheaper and US exports more expensive.
ECB President Christine Lagarde said Thursday that the resurgence of trade tensions could put additional pressure on the eurozone economy’s growth, making a potential case for even lower rates in the 20-country bloc.
“Risks to economic growth are still tilted to the downside,” Lagarde said regarding tariffs that Trump has threatened to impose on a wide range of countries. “One thing we know for sure is that they will have a global negative impact.”
As for European interest rates, “we know the direction of travel,” and it will be downward, Lagarde noted after the ECB’s Governing Council cut the main interest rates by another quarter percentage point. “At what pace, in what sequence, and to what extent will depend on the data we receive.”
Bank of Canada Governor Tiff Macklem also expressed concern about Trump’s tariff threats on Wednesday, as the Canadian central bank made its sixth consecutive rate cut and lowered its economic growth forecasts for the US. “A prolonged and broad-based trade conflict would significantly harm economic activity in Canada,” he said.
Next up could be the Bank of England, which is expected to cut rates next Thursday, possibly doing so at a faster pace than currently expected.
Divergence
The Fed remains on the sidelines. While US central bank policymakers expect to cut rates later this year if inflation moderates as predicted, Fed Chair Jerome Powell said Wednesday there is no reason to rush into the next move.
“We see that everything is in really good shape both for policy and for the economy, so we don’t feel the need to rush adjustments,” Powell told reporters after the Fed’s decision to leave rates unchanged.
This is not the outcome Trump hoped for. Just a week earlier, he said he would “demand” that the Fed chair he appointed cut rates, as he is concerned about the political divergence on the issue. He is expected to replace Powell when his four-year term ends in May 2026.
“I will demand an immediate rate cut. And likewise, they should be cut around the world,” Trump said in a video address at the World Economic Forum in Davos.
However, partial fulfillment of his wish could be even worse than no fulfillment at all, as the divergence between the Fed’s policies and those of its counterparts may put additional pressure on the US dollar, strengthening it. This would make imports even cheaper while Trump is trying to “rebalance” global trade in favor of the US. This is already a challenging task, especially after the record US goods trade deficit at the end of 2024.
In Europe, “the policy divergence between the Fed and the ECB is likely to strengthen the US dollar this week. For further stability, clarity on European policy, an end to the war in Ukraine, no new US import tariffs, and more stable GDP growth are needed,” wrote Macquarie analysts Thierry Wizman and Gareth Berry ahead of the ECB’s policy decision.
The dollar has risen about 7% against a basket of global currencies since September, despite the Fed cutting rates by a full percentage point last year.
“Political Purgatory”
The tone difference between the Fed and other central banks reflects the different economic realities of the US and other countries following the brief but deep recession caused by the COVID-19 pandemic in 2020.
High inflation was a global issue linked to supply chain disruptions, and central banks collectively raised rates to tame it.
However, the causes of inflation differed. Events like Russia’s invasion of Ukraine in 2022 led to rising energy prices in Europe, while significant government spending in the US fueled demand-driven inflation.
Inflation has fallen everywhere, but in the US, this has occurred amid economic growth exceeding trend levels, while Europe is teetering on the edge of recession.
This has placed Trump in a potential dilemma: how to outperform the Biden administration’s economic results in an economy that may already be operating at full capacity. US GDP grew 2.8% in 2024, marking the fourth consecutive year of robust growth compared to a long-term potential of 1.8%.
Inflation is nearly under control, but the Fed sees enough uncertainties and risks to hold off on making changes.
“The Federal Reserve is really in a kind of political purgatory,” said Diane Swonk, chief economist at KPMG, noting that Powell’s responses were filled with phrases like “waiting,” “on pause,” “not rushing,” and “we’ll watch patiently.”
With the Biden administration implementing dozens of executive orders and possibly preparing new trade tariffs, “the Fed doesn’t know what’s coming next,” Swonk added.