Despite the changes announced last week to President Trump’s tariff program, delaying for three months the bigger tariff hikes for some and a reprieve for US IT companies from the super-sized retaliatory tariffs imposed on China, the US Administration remains wedded to reversing decades of change mostly in favour of freer international trade that saw effective tarriff trade protection down below 3% at one point and at around 5% at the end of the Biden Administration. Even with the changes announced last week, trade protection has more than tripled and when the higher tariffs come back into play in July that could lift to 30%.
The last time US tariff protection was so high was back in the 1930s and President Trump has recently praised the 1930 Smoot- Hawley Tarriff Act that raised US Tarriffs around 20 percentage percentage points as a move towards combatting the Great Depression against almost universal economic opinion that it made it worse.
Even with the latest tariff modifications the US will suffer from weaker GDP growth together with higher inflation. Quantifying the extent of the damage is challenging partly because of the usual difficulties in making economic forecasts as well as in the current circumstances the erratic qualities of President Trump who changes policies abruptly and unpredictably. Our rough calculation is that annual US GDP growth will be around one percentage point lower than would otherwise have been the case while US inflation will be about 1.2 percentage points higher.
The forecasting problems are greater when assessing the impact of US tariff policy changes on countries outside the US. Those countries facing higher tariff imposts and with substantial trade links to the US will suffer most. China, for example, subject to the biggest US tariff imposts will suffer as much as three percentage points of lost annual GDP growth on our estimate unless it is quick to take policy initiatives to boost substantially domestic spending. China can also try to boost international trade with trading partners other than the US but that would at best be a partial and slow response to loss of trade with the US.
In contrast, the direct impact of recent US tariff announcements on Australia is comparatively small. It runs to about a 0.1 percentage point detraction to annual GDP growth and a 0.2 percentage point addition to inflation. Additional spending initiatives announced by the Government and Opposition in the Federal Election campaign over the past week would offset the damage to growth from the American tariffs while by boosting demand will add a little more to inflation.
Apart from the direct impact Australia will also be affected by damage to the economic prospects of our major trading partners, especially our biggest trading partner, China. Commodity export volumes and prices are likely to be lower. All told, Australia is likely to suffer some reduction in growth prospects, probably quite small together with addition to inflation.
Some see the damage to Australian economic prospects creating a need for the RBA to cut interest rates more aggressively and quickly than considered likely previously. One or two more 25bps rate cuts thought likely previously changed to expectations of four or five rate cuts perhaps starting with a super-sized 50bps rate cut at the mid-May meeting.
The need for emergency rate cuts was doubtful in our view even before the announcement of pauses on some US tariff hikes over the past week. There appeared to be little risk of substantial reduction in Australia’s growth prospects that would warrant emergency rate cuts. Australia’s growth rate has been picking up pace since mid-2024 and with growing government spending promising to be turbo charged in the election campaign. Financial market turbulence cut into household wealth and that conceivably might dent consumer spending, but the sharp fall in the share market has turned to partial recovery over the past week.
When the RBA meets in mid-May it will probably have evidence that inflation tracked in line with its latest forecasts in Q1 2025 allowing some room to cut the cash rate 25bps to 3.85%. But the inflation outlook looks set to stay quite sticky in the wake of US tariff announcements as well the Australian Federal Election which whoever wins will come with a legacy of even more government spending.
By mid-May with diminished threat of a local recession and with inflation likely to push back up to 3% and more in the first half of next year, the RBA can make monetary policy a little less restrictive, but that provides scope for one or two more 25bps cash rate cuts taking the cash rate down to 3.60% by the end of 2025.
President Trump’s push to take the US and the world back to 1930’s international trading conditions is being watered down. Expectations about what central banks will do in response need to be watered down too. For Australia, less severely impacted by President Trump’s initial tariff proposals than most, the changes over the past week mean that the RBA returns to its previous rate setting trajectory – watch the data and cut modestly when warranted by the data.
There will be a six-week pause before the next economic commentary with the author on leave. The next economic commentary will be out on Monday 2nd June.