US Federal Reserve warns of the growing threat of stagflation as trade war bites

The US Federal Reserve last night warned of the growing threat of stagflation in the world’s biggest economy as it grapples with the impact of US President Donald Trump’s trade war.

Fed chair Jerome Powell said that the steep tariffs announced last month – but which were then postponed for 90 days – would drag down growth and push up inflation if they remain in place.

It came as America’s central bank chose to leave interest rates on hold in a range of 4.25 per cent to 4.5 per cent. 

Powell said: ‘If the large increases in tariffs that have been announced are sustained, they are likely to generate a rise in inflation, a slowdown in economic growth, and an increase in unemployment.’

He said the economy was ‘shrouded in some very downbeat sentiment’, adding: ‘Businesses and households are concerned and postponing economic decisions of various kinds.

‘If nothing happens to alleviate those concerns then you would expect that to begin to show up in economic data.’

The decision to hold rates will have infuriated Trump, who has labelled Powell a ‘major loser’ for not cutting them.

He recently posted on social media that ‘Powell’s termination cannot come fast enough’ – though in the face of market jitters the President later said he had no plans to fire him.

The Fed must respond to the risks posed by Trump’s tariffs on its trading partners.

A key risk is that the tariffs add to prices, driving up inflation, while weakening growth. The dismal combination of stagnating growth and higher inflation is known as ‘stagflation’.

It presents a tricky challenge for central banks as rate cuts can be used to boost the economy but rate hikes are used to keep inflation under control.

The Fed said: ‘Uncertainty about the economic outlook has increased further.’

Recent official figures presented a mixed picture. America added 177,000 jobs last month, beating expectations, and inflation – on the Fed’s preferred measure – has slowed to 2.3 per cent.

But the economy shrank at a pace of 0.3 per cent in the first quarter – a figure that was skewed by a surge in imports in March to get ahead of tariffs, creating a widening trade deficit which weighed on the GDP figures.

Powell said that if the Fed does have to respond to both rising unemployment

and higher inflation at the same time it would then face a ‘complicated and challenging judgment’.

He brushed off Trump’s call for rate cuts, saying that it ‘doesn’t affect doing our job at all’.