Interaction between rotating impeller and stationary diffuser in a centrifugal compressor is of practical importance in evaluating system performance. The present study aims at investigating how the interaction influences the unsteady diffuser performance and understanding the physical phenomena in the centrifugal compressor. A computational fluid dynamics (CFD) method has been applied to predict the flow field in the compressor, which has a conventional vaned diffuser (VD) and a low solidity vaned diffuser (LSVD). The radial gaps between impeller and diffuser and different flow coefficients are varied. The results obtained show that the major parameter that influences the unsteady variation of diffuser performance is due to the circumferential variation of the flow angle at the diffuser vane leading edge. The physical phenomena behind the pressure recovery variation are identified as the unsteady vortex shedding and the associated energy losses. The vortex core region as well as the shedding of vortices from the diffuser vane are triggered by the variation in the diffuser vane loading, which in turn is influenced by the circumferential variation of the impeller wake region. There is little unsteady variation of flow angle in the span-wise direction. This indicates that the steady state performance characteristics are related to the span-wise variation of flow angle, while the unsteady characteristics are contributed by the circumferential variation of flow angle. At design conditions, dominant frequency components of pressure fluctuation are all periodic and at near stall, these are aperiodic.