How trade tariffs could affect U.S. inflation, Fed

Federal Reserve Chairman Jerome Powell says that the central bank has tools it could use to cushion the adverse effects a trade war might have on the economy. But he tells Congress the effort could be challenging if higher tariffs push inflation up too sharply.

Powell says if the retaliatory tariffs imposed by other countries caused the U.S. economy to slow, the Fed could employ its normal tools, such as lowering interest rates.

But he says that could become complicated if higher U.S. tariffs on foreign products caused inflation to accelerate. That’s because the Fed’s normal response to higher inflation is to raise interest rates, not lower them.

“If we do have higher inflation, that could be very challenging for policy,” Powell says.

So far, however, inflation remains relatively tame. For example, core CPI in the U.S. was running at just 1.7% on a three-month annualized basis in June.

In an economics report, National Bank economist Krishen Rangasamy notes that inflation is lifted when stronger demand meets higher costs from import tariffs or labour market tightness—at least in theory.

While there’s evidence of higher demand, he says, there’s little evidence of higher costs based on tame import prices, as well as still-soft wage growth.

Read: U.S. inflation, at 2.9% in June, may be tamer than it looks

“Import prices are being restrained by an appreciating U.S. dollar, which is offsetting impacts of higher tariffs,” he says.

Even with further tariffs, consumer prices might not rise significantly, since importers might avoid passing increased costs on to consumers, as a way to keep market share.

In the unlikely scenario that importers do pass full costs on to consumers, Rangasamy says the overall impact on inflation would be cushioned by “the relatively small import content in overall U.S. personal consumption expenditures.”

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