By Balazs Koranyi and John Revill

FRANKFURT/ZURICH (Reuters) – Central banks worldwide have ample capacity to continue cutting interest rates, suggesting a potential separation from the U.S. Federal Reserve’s policies. As the Fed pauses its own rate cuts, challenges arise for U.S. President Donald Trump, who may find his trade tariffs less impactful, along with fears that U.S. businesses and consumers might face higher borrowing costs.

The Fed typically spearheads global monetary policy. However, the start of 2025 presents an unusual situation: while the U.S. economy thrives, many other large economies are struggling, compounded by uncertainty surrounding Trump’s trade policies, limiting the Fed’s ability to lower rates further.

Ironically, the global economy’s adaptation to a threatened trade war is diminishing the aims of Trump’s tariffs before their implementation, benefiting foreign firms that sell to U.S. consumers. Tariffs generally raise domestic inflation, prompting the Fed to maintain elevated interest rates, which strengthens the dollar and encourages exports to the U.S., contrary to the administration’s intentions.

For instance, Switzerland is already experiencing economic advantages. “A weaker franc would also aid Swiss industry by making U.S. exports cheaper,” remarked Karsten Junius, chief economist at J.Safra Sarasin. This could mitigate the effects of any U.S. tariffs.

The 20-member eurozone, often targeted by Trump for its trade surplus, could also alleviate some tariff impacts through a currency that has depreciated by 7% since early autumn. “To preserve their market share, European companies may be willing to accept reduced margins,” commented European Central Bank board member Piero Cipollone, suggesting that the overall effects may be modest through adjustments in exchange rates.

Weak currencies typically cause inflation by raising import costs, particularly for energy. However, many areas are experiencing declining inflation owing to weak growth influenced by trade tensions, with policymakers appearing unconcerned thus far.

Recently, the ECB, Bank of England, and Bank of Canada cut interest rates, contrasting the Fed’s cautious stance. The Reserve Bank of India and the Bank of Mexico also lowered rates, albeit from higher levels.

Tiff Macklem, Canada’s central bank chief, noted that interest rate differences have had a “relatively modest” currency impact, while the Bank of England described the sterling’s decline—a 7% drop against the dollar since September—as minor.

“The euro went from $1.12 last year to $1.01 on Monday. Is this truly a game changer for the ECB or any central bank? I don’t think so,” stated Amundi’s global FX head, Andreas Koenig.

LIMITS

Indications suggest that Trump, who recently called for Fed rate cuts, has revised his view on U.S. interest rates. Treasury Secretary Scott Bessent clarified that Trump’s calls for lower rates refer to the yield on 10-year Treasury notes—crucial for U.S. mortgage and bank lending rates—rather than the Fed’s short-term rate.

Disparities in policy are largely influenced by economic fundamentals, as the U.S. economy’s performance necessitates higher interest rates to manage inflationary pressures.

However, this interest rate gap cannot persist indefinitely. “What concerns central bankers… is significant currency depreciation leading to bond market sell-offs, further currency weakness, and inflation,” commented Dominic Bunning, Nomura’s global forex strategist. He added, “Such spirals are what central banks need to manage, but I don’t foresee that happening.”

Policymakers may also hesitate if energy prices surge again, which could amplify inflation through rising oil and gas costs typically traded in dollars.

An additional challenge is that while central banks can lower short-term rates, long-term borrowing costs are determined by market rates. If U.S. yields rise, others are likely to follow suit, increasing borrowing expenses and hindering economic growth.

“Usually, if U.S. yields fluctuate, European bonds follow suit,” noted GianLuigi Mandruzzato, an EFG Bank senior economist. “As a result, businesses and consumers may confront higher borrowing costs, despite decreased short-term rates by central banks.”