Central banks worldwide retain significant capacity to reduce interest rates, potentially diverging further from the U.S. Federal Reserve’s current pause on policy easing, according to policymakers and analysts. This divergence could impact U.S. President Donald Trump’s trade strategies and potentially increase borrowing costs for American businesses and consumers.
The global economic landscape in 2025 presents a unique scenario. While the U.S. economy remains robust, other major economies face challenges. This, coupled with uncertainties stemming from Trump’s policies and trade tensions, restricts the Fed’s ability to implement further rate cuts.
Paradoxically, the global response to potential trade wars is mitigating some intended effects of Trump’s tariffs, benefiting foreign companies exporting to the U.S. High U.S. interest rates, aimed at controlling inflation fueled by tariffs, strengthen the dollar. Consequently, exporting to the U.S. becomes more profitable, counteracting the administration’s objectives.
Switzerland, for instance, is already experiencing this advantage. A weaker Swiss franc, resulting from the strong dollar, reduces export prices to the U.S., potentially offsetting the impact of any imposed tariffs, according to Karsten Junius, chief economist at J.Safra Sarasin.
The euro zone, a frequent target of Trump’s trade rhetoric, could also mitigate tariff effects through a weakened euro. European Central Bank board member Piero Cipollone suggests European companies might absorb some tariff costs by reducing profit margins, partially compensated by the favorable exchange rate.
While a weak currency typically fuels inflation by increasing import costs, current global inflation is declining, largely due to trade friction-induced slow growth. This allows policymakers to remain unconcerned about recent currency fluctuations.
Despite the Fed’s inaction, the European Central Bank, the Bank of England, and the Bank of Canada have recently cut interest rates. The Reserve Bank of India and the Bank of Mexico also reduced rates, albeit from higher starting points.
Officials downplay the currency impact of these diverging interest rate policies. Tiff Macklem, Canada’s central bank chief, describes the effect as “relatively modest,” while the Bank of England considers sterling’s decline against the dollar minor. Amundi’s head of global FX, Andreas Koenig, echoes this sentiment regarding the euro’s depreciation against the dollar.
Recent indications suggest a shift in Trump’s perspective on U.S. interest rates. Treasury Secretary Scott Bessent clarified that Trump’s desire for lower rates pertains to the 10-year Treasury note yield, which influences mortgage and business loan rates, rather than the Fed-controlled short-term rate.
Underlying economic fundamentals also contribute to the policy divergence. The stronger U.S. economy necessitates higher interest rates to curb inflation.
However, this interest rate gap has limitations. Nomura’s global forex strategist, Dominic Bunning, highlights the concern of significant currency weakness triggering a bond market selloff, further weakening the currency and fueling inflation. While acknowledging this potential spiral, Bunning believes it’s unlikely.
Potential triggers for policy adjustments include a surge in energy prices, potentially exacerbating inflation due to dollar-denominated oil and gas sales.
Furthermore, while central banks control short-term rates, market forces dictate long-term borrowing costs. Rising U.S. yields often influence other markets, potentially increasing borrowing expenses and hindering economic growth globally. GianLuigi Mandruzzato, senior economist at EFG Bank, notes that rising U.S. yields typically lead to similar increases in European bond yields, impacting borrowing costs for companies and households despite central bank efforts to reduce short-term rates. This complex interplay of global economic factors and diverging monetary policies warrants close monitoring.
