The global economic outlook is becoming more volatile and challenging. Global growth will face a stiff headwind from President Trump’s imposition of higher tariffs on US imports. Where many of those tariff changes will settle is still in the air with unreliable deadlines in July for when countries have been ordered to strike trade deals with a now war-distracted US Administration. Without the details of where the US import tariffs will settle it is hard to make a credible estimate of how much global growth prospects will be damaged or how much inflation will lift in various countries.
What is more certain is that because the actual imposition of some of the tariffs still lies ahead (probably in July) much of the damage to global growth and upward pressure on inflation also lies ahead in late-2025 and in 2026.
Adding to this uncertainty about the global economic outlook is now the escalation of the war in the Middle East with the US actively entering the fray and bombing Iran’s nuclear facilities at the weekend. Experienced geopolitical analysts (which we are not) are struggling with the many permutations of how Iran may respond as well as the counter-response of the US beyond.
What can be said with any cofidence is that global growth and inflation prospects have become even more uncertain as we ponder the potentially devastating impact on global supply chains especially for energy. Countries have further cause to lift military spending and for some placing more pressure on already over-stretched budgets and public sector borrowing. These are just one or two of the issues that may arise.
For Australia, it is imperative that the local economy is resilient, meaning in good enough shape to keep growing in the face of mounting disturbance internationally while also keeping a lid on inflation. Australia’s ‘local resilience score-card’ is mixed. The demand side of the economy may weather through the next year or two of headwinds from overseas, but the supply side is in poor shape and that implies Australia is at risk of inflation firing up again.
On the demand side, real growth is mostly baked in to government spending over the next couple of years largely from the Federal Budget delivered back in March. In The Q1 GDP report, real government consumption spending was up 3.4% y-o-y while real government investment spending was up 5.1% y-o-y. These strong annual real growth numbers may moderate over the next two years but will still run at least 2.0% y-o-y in real terms.
The biggest part of spending in the economy by far is household consumption spending. That is growing slowly, up 0.7% y-o-y in Q1 in real terms. There is potential for household consumption to grow faster largely because of growth in household income. Wages have been growing in real terms for more than a year and are up more than 1% y-o-y on the latest Q1 wage and inflation data. Real household disposable income is growing even faster assisted by mortgage interest rate cuts, income tax cuts in 2024-25 plus more generous government payments. For the time being, households are allocating their greater income to spending and saving, but that could change with greater allocation to spending.
One factor pointing towards a greater allocation of rising income towards spending by households is the already evident lift in spending on housing. Housing spending has been lifting sharply since mid-2024 and is up 5.6% y-o-y in real terms in Q1 2025. Invariably a strong lift in housing spending precedes a lift in real household consumption spending. It is the main reason why we expect growth in household consumption expenditure to lift later in 2025 and in 2026.
The softest part of spending in the economy is business investment spending, in particular spending on machinery and equipment, -3.7% y-o-y in Q1. Business investment spending has been languishing for years. That has meant that whenever demand in the economy has risen businesses have tended to lift output by putting on more labour. Persistently weak investment spending running along side mostly strong demand for labour has kept productivity very weak (real GDP per hour worked was down 1.0% y-o-y in Q1 and showing little sign of improving).
Most parts of domestic spending in the Australian economy look set to provide a good buffer against the international trade demand and supply shocks thrown up by President Trump’s tariffs and the evolving Middle East conflict. The supply-side of the Australian economy, however, is limited by longstanding poor business investment spending and productivity. That makes the Australian economy vulnerable to the higher inflation pulse from overseas likely to arrive later this year.
We reaffirm our view that the RBA has some capacity to cut the cash rate further over the next few month – perhaps by another 50bps to 3.35%. But the stay at the bottom of the interest rate cycle is likely to be short-lived. We see the RBA needing to consider rate hikes again from mid-2026.