By Balazs Koranyi and Howard Schneider
FRANKFURT (Reuters) -Europe’s central banks stood in stark contrast to their U.S. counterpart on Thursday, cutting interest rates or hinting at policy easing to come, even as the Federal Reserve kept a steady hand overnight and left investors guessing about its next move.
Most of the world’s biggest central banks have been cutting borrowing costs this year due to slowing inflation, diverging from the Fed, normally the world’s trendsetter, as the U.S. could now be facing an inflation surge from the fallout of a global trade war.
Tariffs will disproportionately hit the U.S., the world’s largest consumer, as the new duties along with the sharp weakening of the dollar make imported goods more expensive. By contrast, the rest of the world could face slower inflation via weaker trade, a stronger currency against the dollar and lower energy costs.
The Bank of England cut interest rates by 25 basis points and hinted at more easing, while Sweden’s Riksbank and Norway’s Norges Bank both said that rate cuts are likely coming, with all three citing tariffs as a threat to growth.
The ECB, which only meets in early June, has also been preparing markets for its eighth rate cut in 13 months, arguing that inflation is now essentially on target and tariffs will hurt growth.
By contrast, the Fed warned Wednesday evening that the turbulence could push up both inflation and unemployment, opposing forces that call for different policy responses, a hint that the world may be facing a lengthy wait for clearer guidance.
“There’s no real cost to our waiting at this point,” Fed Chair Jerome Powell said. “There should be some increase in inflation, there should be some increase in unemployment. Those call for different responses.”
The BoE on the other hand saw no reason to wait as it cut its key rate to 4.25% and even debated a bigger move, warning that tariffs have increased uncertainty and will likely lower global growth.
“The past few weeks have shown how unpredictable the global economy can be. That’s why we need to stick to a gradual and careful approach to further rate cuts,” BoE Governor Andrew Bailey said.
Central banks in Norway and Sweden kept rates unchanged for now but both made explicit references to possible policy easing to come.
“The uncertainty resulting from the new US trade policy may put downward pressure on inflation in Europe,” the Riksbank said. “Short-term inflation expectations have risen in the United States, while they have fallen in the euro area.”
SHOCKS
Most central banks, however, emphasized that trade shock is beyond what they are normally used to and they lack the tools to handle a rapidly changing situation that primarily impacts supply, rather than demand.
The turbulence could drag the U.S. into a recession but that would be more akin to the pandemic, with the exception that it is largely driven by government officials, with the power to change course at will.
“That’s very different from a typical recession caused by weakening demand,” said Jean Boivin, the Head of the BlackRock Investment Institute.
“It’s more akin to what we saw in the pandemic: supply disruptions quickly leading to a contraction, but activity can also pick up again quickly if and when those disruptions dissipate,” Boivin added.
The real issue for central banks is that any decision they take now impacts the economy on a 12- to 18-month horizon. But political decisions move much faster and banks have little visibility over what is to come.
So their main job for now is to maintain financial market confidence and prevent any inflationary impact from tariffs becoming embedded.
“One reason why few expect tariffs alone to create an inflationary cycle is that the FOMC intends to keep making it unprofitable,” Steven Blitz at TS Lombard said.
“Here, however, is where recession can begin,” Blitz said. “Margin squeeze from higher tariffs and a limited ability to pass the price hike forward, eventually turns into a credit squeeze as firms appear less able to meet credit obligations — and that eventually becomes layoffs.”
(Editing by William Maclean)
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