Fed keeps rates unchanged: rising risk of inflation and unemployment

How to defy political pressure. The Fed leaves the cost of money unchanged, as widely expected. Interest rates remain firm in a range between 4.25 % and 4.50 %. Into thin air, again, went the attempts of President Donald Trump, who had 'threatened' and wished for the 'sacking' of Chairman Jerome Powell, to obtain a lower official cost of credit.

The diagnosis of the economic situation, contained in the initial communiqué, shows few but not marginal changes compared to the March note. Uncertainties, first of all, have 'further' increased. The Fed recalls that the GDP figures - the 0.3 per cent decline in the first quarter - were 'marked by fluctuations in net exports', which rose sharply in anticipation of tariffs, while - Powell added at the press conference - private domestic demand grew by 3 per cent (annualised quarterly), the same level as last year. Unemployment, the chairman added, is at or near its highest level. Inflation, Powell further said, "has eased significantly from its mid-2022 highs, but still remains somewhat elevated relative to our long-term target of 2 per cent".

The Fed statement indicates that 'the risks of higher unemployment and higher inflation have increased': this is the worst case scenario for all central banks and in particular for the Fed, which formally has a dual mandate, price stability and maximum employment. Two objectives that may be incompatible, as in the current situation, even if they are a temporary supply shock - albeit with structural effects - that could lead to 'ignoring' - Chairman Jerome Powell has already spoken of this - the acceleration of prices, despite the consequent increase in their level. "We may find ourselves," he also said at this May meeting, "in the difficult situation where our dual mandate objectives are in conflict. If that were to happen, we might consider how far the economy is from each target and the different time horizons in which those gaps are expected to close. For now, we are well positioned to wait for more clarity before considering any adjustments to our monetary policy stance."

The effect of the tariffs is still very uncertain. "So far," Powell said, "the tariff increases announced have been significantly larger than anticipated. All of these policies are still evolving and their effect on the economy remains highly uncertain. As economic conditions evolve, we will continue to determine the appropriate monetary policy based on incoming data, the outlook, and the balance of risks. If the announced rate increases are maintained, they are likely to lead to higher inflation, an economic slowdown and higher unemployment. The effects on inflation could be short-lived, reflecting a one-off change in the price level. It is also possible, however, that inflationary effects will be more persistent. Avoiding such an outcome will depend on the size of the impact of the tariffs, the time it takes for them to be fully passed through to prices and, ultimately, on keeping longer-term inflation expectations well anchored'.

The situation is still developing rapidly. "Should the tariffs ultimately be applied at these levels, which we do not know at this time," Powell warned, "we think there will be no further progress towards our objectives. The decision not to touch tariffs stems, for Powell, from this assessment: 'We think our monetary policy rate is well-positioned while we await more clarity on tariffs and, ultimately, their implications for the economy,' he said and repeated. Monetary policy "is 100 basis points less restrictive than it was last autumn, and that puts us in a good position to wait and see how things develop. We don't think we have to rush; we think we can be patient'.