The growing global financial ties that interconnect economies, investors and markets have profound implications for the economic outlook, the way economies respond to shocks and the formulation of policy responses. The sharp increase in tariffs this year was expected to lower growth and create difficult policy trade-offs for central banks. However, the economic impact so far has been relatively mild. This outcome was supported by easy financial conditions, driven in part by a US dollar depreciation, which was itself driven by financial factors. The key role of financial factors reflects the rise in financial interlinkages, including through cross-border bond holdings and FX derivatives markets. While buoyant financial conditions cushioned the tariff shock, a deterioration in asset markets and a tightening of credit conditions could expose vulnerabilities. Policymakers must complement their assessment of economic activity with close consideration of the large and growing financial interlinkages and their transmission to financial conditions.
