US tariffs upend central bank plans

By the OFX team | 7 May 2025 | 6 minute read

We’ve seen how US President Trump’s tariffs have impacted investors and market traders, but spare a thought for the globe’s central banks, whose carefully laid plans and policies have been crumpled by “Liberation Day.” Trump’s tariffs have darkened the global economic backdrop, effectively forcing the major central banks to reassess their next steps.

The Fed pauses amid rising uncertainty

Before the tariffs hit, the Federal Reserve’s (Fed) main goals in 2025 were to keep inflation in check and employment high. The Fed had been optimistic that the US economy was moving closer to its targeted “soft landing”, in which inflation returns to “normal”, the employment market stays strong, and the economy keeps growing. But Trump’s tariffs and the ensuing trade war has ratcheted-up the uncertainty for US businesses and financial markets, putting the Fed’s hoped-for path in danger.

Coming into 2025, the Fed was well into its rate-cutting campaign, having cut the borrowing rate three times in 2024, to a range of 4.25%–4.5%. The central bank had commented in the December quarter on a strong and improving US economy, signalling that it would likely lower the rate twice more in 2025. Some Fed officials – and the markets – were predicting more cuts than that. However, In January, Federal Reserve Chairman, Jerome Powell indicated that the Fed would pause any further cuts, given signs that inflation remained stuck well above its long-term target of 2%.

US inflation subsided more than expected in March, from an annual rate of 2.8% in February to 2.4% on a year-on-year basis (as measured by the Consumer Price Index (CPI): the Federal Reserve prefers to focus on a different measure, annual change in the Personal Consumption Expenditures (PCE).) Excluding food and energy, so-called ‘core’ inflation came in at 2.8%, the lowest rate for core inflation since March 2021. With inflation falling, there would typically be a case for the Fed to lower US rates – and that is certainly what the White House wanted — but then came the tariffs.

The Federal Reserve is well aware that tariffs are inflationary: the prospect of high inflation flowing from widespread tariffs along with slower hiring was specifically mentioned in the minutes from the March meeting, released in early April. If inflation remained higher, the Fed could keep its benchmark interest rate unchanged. But the risks of simultaneously higher inflation and slower growth implied that “difficult tradeoffs” could lie ahead for the central bank. As Reuters noted¹, “the March 18-19 Fed meeting was held in the wake of initial Trump administration tariff plans that raised uncertainty about the economic outlook and led participants to favour (sic) a ‘cautious approach’ that could opt to keep interest rates higher for longer if inflation were to persist, or cut rates if a weakening economy needed more immediate attention”.

For now, the US dollar index (DXY) is down 7.9% year-to-date, weakening on waning US growth expectations, as traders wait to see whether and to what extent this “cautious outlook” prevails – while President Trump fumes about rates not being cut, and openly ponders firing Chair Powell. That is an eventuality that could tip a softening US dollar into a full-blown slump.

Europe responds with measured cuts

Over in Europe, the European Central Bank (ECB) cut² its main interest rate by a quarter of a percentage point in mid-April, specifically citing growing trade tensions after US President Donald Trump’s tariffs sparked a global trade war. But given that the ECB’s rate cut, from 2.5% to 2.25%, was the seventh such change in the past year, it was hardly a shock.

Earlier this month, the Euro zone inflation figure for April came in unchanged at an annual rate of 2.2%, which was widely construed in the markets as implying further ECB interest rate cuts. With a highly uncertain trade outlook, the ECB refrained from opining on the future direction of rates; but analysts note that strong reserve demand and expectations of Euro zone economic growth on higher defence and infrastructure are continuing to help the euro shine in 2025 against both the greenback and sterling.

Currency pressures hit Switzerland and Japan

Outside the EU, the Swiss National Bank is one of the most affected of its peers, given that Switzerland’s currency has surged as investors seek a haven from tariff turmoil, and the nation is an export-driven economy. The Swiss franc has soared to a decade high against the dollar in the rush for shelter, sparking speculation that the country’s central bank will have to lower interest rates to zero or below to try to limit the currency’s rise. That is not what the SNB wants to do: as one strategist notes, the Swiss are in a “staggeringly difficult” position³.

In Japan, the Bank of Japan (BoJ) began the year with a case for more interest rate hikes, which was strengthened in February when inflation in Japan rose to a two-year high of 4%, on the back of GDP data showing that Japan’s economy grew faster than expected in the final quarter of 2024. In January, the BoJ hiked interest rates by 25 basis points, the biggest rate hike since February 2007, from 0.25% to 0.50%, the highest level for the Japanese official rate since the 2008 global financial crisis. At the time, the BoJ reiterated that it would continue to raise the policy rate if the outlook it presented in its January Outlook Report were realised – but then came the tariffs. This month, the central bank held its policy rate at 0.5% and reduced its growth outlook, bowing to the sheer uncertainty of the external environment in respect of US tariff policies. The markets do not appear to believe the BoJ can tighten now – as Forbes magazine eloquently puts it,³ “Trump’s tariff chaos tosses Bank of Japan under the bus”.

China and Australia brace for aftershocks

Across the East China Sea in Japan’s main economic engine, China, the People’s Bank of China (PBOC) is dipping into its kitbag to deploy the full array of stimulus and support measures – closely co-ordinated with the leadership compound in Zhongnanhai – to support the Chinese economy and capital markets. In foreign exchange terms, after a depreciation scare in the immediate wake of “Liberation Day” – remember, the PBOC used yuan depreciation to help exporters during Trump’s first-term tariffs – but that depreciation pressure faded relatively quickly, and the PBOC has stabilised the currency to where it was prior to the tariff announcements.

Lastly, in Australia, in February, the Reserve Bank of Australia (RBA) cut rates for the first time in five years, but it has not moved since (the central bank did not want to involve itself in the election campaign, keeping rates unchanged in April). But with global economic growth coming under pressure from a trade conflict between the US and China (Australia’s biggest trade partner), future market pricing currently implies an expectation of more than one full percentage point of RBA rate cuts by the end of the year – with pretty clear ramifications for Aussies.

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