Unlock the White House Watch newsletter for free
Your guide to what Trump’s second term means for Washington, business and the world
The gulf between borrowing costs in the US and Eurozone has reached the greatest level since before the Covid-19 pandemic and is set to widen further, just as Donald Trump grows increasingly frustrated at the US Federal Reserve’s wait-and-see approach to rate cuts.
The difference in interest rates has increased to over 225 basis points — the biggest divide since September 2019 — after the European Central Bank on Thursday lowered borrowing costs by a quarter-point to 2 per cent.
As the Fed is expected to sit tight at least until after the summer, while at least one more cut by the ECB this year seems likely, the gap can widen even more.
The ECB and the Fed “will continue to diverge for quite some time”, said Mahmood Pradhan, global head of macro at Amundi Asset Management.
“Inflation will take longer to come down in the US, the Fed will need to be patient. But there’s nothing holding back the ECB.”
Desperate for lower US borrowing costs, Trump has repeatedly highlighted the transatlantic monetary policy divide.
After US jobs data showed weakening employment growth on Friday, the US president intensified his attacks on Federal Reserve chair Jay Powell — whom he nicknames “Too Late”.
“‘Too Late’ at the Fed is a disaster!” Trump wrote in a Truth Social post. “Despite him [Powell] our Country is doing great. Go for a full point, Rocket Fuel!”
The cut announced by ECB president Christine Lagarde a day earlier was the eighth such move in a year, compared with just four similar steps by the Fed over the same period. Since January US policymakers have kept the fed funds rate between 4.25 to 4.5 per cent — now more than twice the level of borrowing costs in Europe.
Trump’s trade threats and other actions are distorting one of the channels that usually keeps the gap between borrowing costs across advanced economies in check: exchange rates.
Some content could not load. Check your internet connection or browser settings.
In normal times, higher US interest rates would boost the dollar. They make US assets more attractive and tend to reflect higher growth rates.
But the shock of Trump’s policymaking, combined with the prospect of a sharp rise in US budget deficits due to planned major tax cuts, has led global investors to rethink their exposure to the world’s largest economy, weighing on the value of the US currency. The euro is up 13 per cent against the dollar since mid-January.
“Normally being an FX strategist is a very easy job — you just look at the interest rate differential between two economies. For a long time the euro-dollar rate moved together with that [differential],” said Torsten Sløk, chief economist at Apollo Global Management. “But that relationship broke down completely when the trade war began.”
“From the perspective of the currency market, the Fed is keeping monetary policy tight for bad reasons, while the ECB is cutting for good reasons”, said Sam Lynton-Brown, global head of macro strategy at BNP Paribas.
US rate setters were holding rates at the current level, not because economic growth was “extraordinarily strong”, but because of “tariff-induced inflation”, Lynton-Brown said, while the ECB was cutting in response to “disinflationary pressure”, while growth was still “around trend” and “set to recover in 2026”.
Some content could not load. Check your internet connection or browser settings.
While inflation in the Eurozone fell below the ECB’s medium-term 2 per cent target in May and is expected to fall to just 1.6 per cent next year, the Fed’s preferred inflation metric is expected to rise from its current level of 2.1 per cent to above 3 per cent by the end of the year.
“The trade shock now looks set to push inflation higher in the US and inflation lower in the Eurozone,” said Krishna Guha, at Evercore ISI.
For the Euro area, Lagarde signalled on Thursday that policymakers had “nearly concluded” their current rate cutting cycle. Markets are expecting the Frankfurt-based institution to make another quarter-point reduction in the second half of the year. Such a move could widen the gap in interest rates between the US and Europe to more than 250 basis points.
Matters could easily become more extreme if trade talks fail and Trump delivers on his most aggressive threats. Some economists think rates in Europe could fall below 1 per cent if the trade war gets out of hand. Should the Fed continue to sit tight, this would be stretching the gulf to more than 325 basis points — the widest since 2006.
Fed watchers believe officials will almost certainly hold rates at their meeting in mid-June and will not have enough evidence on the impact of tariffs on inflation and jobs until at least the late summer or early autumn.
Alberto Musalem, St Louis Fed president, told the Financial Times on Friday that there was a “50-50” chance that Trump’s trade policies would have an enduring impact on US inflation.
Christopher Waller, a governor at the Fed’s board who is among the more dovish US rate-setters, said in Seoul on Monday that he did not believe tariffs would have a persistent impact on US prices. But he added that the strength of the US labour market meant he had “additional time” to decide whether to support a “good news” rate cut later this year.
While optimists hope that a series of trade deals could bring clarity to US policy after the summer, Claudia Sahm, chief economist at New Century Advisors and a former Fed official warned this was unlikely: “The way negotiations are going on we’re going to be having a conversation about the uncertainty around tariffs for the entire four years of this [presidential] term.”
Additional reporting by Kate Duguid in New York and data visualisation by Janina Conboye
