WASHINGTON (AP) — Ongoing threats of tariffs from Washington, combined with potential wide-scale cuts to government jobs, have significantly dampened consumer sentiment, which may be impacting what is otherwise a largely stable economy.

Recent data released on Friday indicated that consumer spending fell by the steepest margin since February 2021, despite a rise in incomes. On a brighter note, inflation appears to be easing; however, President Donald Trump’s threats to implement substantial import tariffs on Canada, Mexico, and China—key trading partners for the U.S.—are expected to drive prices up, according to economists. Some businesses are already contemplating price increases as a reaction.

In January, Americans reduced their spending by 0.2% compared to December, as reported by the Commerce Department on Friday, likely influenced by unseasonably cold weather. This decline could also signal a more cautious approach from consumers amid growing economic uncertainty.

“The unpredictable news coming out of Washington D.C. is likely causing businesses to hold back and seems to be affecting consumer behavior,” noted Stephen Stanley, chief U.S. economist at Santander, in an email.

The dip in consumer spending, along with a spike in imports during January—likely as companies aimed to preempt impending tariffs—has led Atlanta’s Federal Reserve branch to forecast a 1.5% annualized contraction of the economy in the January-March quarter, a significant slowdown from the 2.3% growth seen in the last quarter of the previous year.

Despite this, most analysts remain optimistic about the economy’s expansion in the first quarter, albeit at a considerably slower rate. Stanley has revised his growth estimate for the first quarter down to 1.25%, from around 2.25%.

Inflation eased to 2.5% in January compared to a year prior, down from 2.6% in December, according to Friday’s report from the Commerce Department. When excluding the more volatile food and energy sectors, core prices decreased to 2.6%—the lowest since June—down from 2.9%.

Economists suggest that inflation is likely to continue declining, but this progress may be disrupted by tariffs. On Thursday, Trump declared plans to impose 25% tariffs on imports from Canada and Mexico, with a lower rate of 10% on Canadian oil, and announced his intention to double tariffs on Chinese imports to 20%.

Moreover, Trump is advocating for significant layoffs of federal employees, which could lead to job losses numbering in the hundreds of thousands and a potential increase in the unemployment rate.

Randy Carr, CEO of World Emblem, expressed that the proposed tariffs may compel him to increase prices and reduce workforce levels. World Emblem, which produces patches, labels, and badges for various sectors, sources roughly 60% of its products from Mexico. Carr indicated that, should the 25% import duties materialize, he anticipates raising prices by 5% to 10% and plans to cut a few positions from his workforce of 500 in the U.S. to manage the rising costs.

Carr also mentioned that he would abandon plans for approximately $9 million in investments related to artificial intelligence and e-commerce initiatives.

“It’s incredibly frustrating,” he remarked. “We’re currently faced with this uncertainty, which makes planning impossible. We’ll have to wait for a definitive decision from the administration. Ultimately, it’s not just affecting Mexico; it’s impacting us all.”

The Federal Reserve’s inflation monitors indicated in January their intention to maintain the short-term interest rate at 4.3% to temper borrowing and spending enough to bring inflation back to their 2% target. The Fed’s heightened rate has already contributed to increased borrowing costs for mortgages, auto loans, and credit cards.

The Fed favors Friday’s inflation measurement over the more commonly recognized consumer price index, which rose for the fourth consecutive month in January to 3%. This measure calculates inflation using a slightly different methodology, assigning less weight to housing and used car costs.

Inflation surged to its highest level in four decades in 2022, contributing to Trump’s election and prompting the Fed to quickly raise interest rates to control prices. Since then, inflation has decreased from a peak of 7.2%, with some economists anticipating it could approach 2% in the months ahead if tariffs are avoided.

“The inflation figures may be skewed higher at a time when the Fed would otherwise be poised to declare victory,” Stanley commented.

One positive aspect of the current report is that incomes rose by 0.9% in January compared to December, largely driven by a significant cost-of-living adjustment for Social Security recipients.

Despite this rise in income, Americans reduced their expenditures, especially on vehicles, where purchases saw a notable decline. Some consumers might be attempting to save after extravagant spending during the holiday season, noted economists, who pointed out that credit card debt surged in December.

A key concern moving forward is whether the proposed tariffs will lead to increased inflation, a slowing economy, or—potentially—the harmful combination of both.

Jeffrey Schmid, president of the Kansas City Fed branch, stated on Thursday that he is becoming “more cautious” about inflation, partly due to consumer expectations of rising prices in the near future.

He added that conversations with businesses in his area suggest that this significant uncertainty could hinder economic growth. While a weakened economy typically prompts the Fed to lower interest rates, persistent inflation would likely keep rates in check.

Several toy companies had expressed relief at Trump’s announcement of merely a 10% hike in tariffs on Chinese goods, believing they could share the additional costs with retailers. However, a 20% tariff means many will have to raise prices significantly. Reports suggest that approximately 80% of toys sold in the U.S. are manufactured in China.

Curtis McGill, CFO of the small toy manufacturer Hey Buddy Hey Pal, described the situation as “a nightmare scenario.”

McGill had just finalized pricing for a toy with a major retailer on Wednesday, only to withdraw it upon hearing about the new tariffs. For the upcoming holiday season, he projects that his products will see a price increase of about 10%.

Walmart, the country’s largest retailer, recently highlighted concerns regarding consumer health and lowered its sales growth forecasts for the year, resulting in a dip in share prices.

Concerns that tariffs could drive up prices have caused a steep drop in consumer confidence, reversing the modest recovery observed after the elections.

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D’innocenzio reported from New York, with contributions from AP Writer Josh Boak.