Last week US voters provided a sweeping victory to Donald Trump, the US Federal Reserve announced a 25bps cut to the Federal Funds rate to 4.75% and indicated more cuts to come and China’s National Peoples’ Congress announced a large spending package to help local government deal with its hidden debt problem. It was a big week of announcements and changes in the world’s two biggest economies and implies stronger global economic growth developing in 2025 and 2026 than previously expected, although not much stronger. Also, inflation in the US is likely to be higher than previously expected in 2025 and more particularly in 2026 and beyond. The higher US inflation outlook may mean that the Federal Reserve is limited in how far it can cut interest rates in 2025 and may need to make an early start raising interest again in 2026 or 2027.
Donald Trump has managed a sweeping victory in the US Presidential Election taking 312 electoral college votes, substantially more than the 270 needed for victory. Republicans also have a majority in the US Senate and likely in the Congress too. Donald Trump can deliver his economic policy agenda once inaugurated in late-January 2025. That policy agenda is only loosely defined at this stage but includes immigration cuts, extensive tariff protection for US businesses especially against goods produced in China, corporate tax cuts and reduction in red tape and regulations impacting US businesses.
Until the details of these economic policy changes are provided it is hard to be precise about their impact. However, if the policy agenda is applied as described above it would lead to greater US domestic demand (partly at the expense of demand growth elsewhere in US trading-partner economies); the US labour market would remain tighter for longer partly because of stronger US domestic demand but also because labour supply growth will be limited by lower immigration; wage growth will be higher than expected previously and inflation pressure will strengthen and not just on higher wage growth but also because of the higher price of imports.
The US Federal Reserve still has some leeway to cut the Federal Funds rate further because at 4.75% the current Funds rate is still high relative to inflation with the CPI at 2.4% y-o-y in September and likely to fall a little further through mid-2025. By late 2025, however, inflation is likely to start lifting again, Federal Reserve rate cuts will stop, and the Fed will need to start considering when to start hiking rates to contain inflation.
In China, the authorities are stepping up measures to try and stimulate flagging economic growth. The centre piece of the latest stimulus package announced last week is a reduction of local government hidden debt. Essentially local government in China is in no position to be able to channel additional spending to prop up the economy because the sector is sitting on a mountain of undisclosed debt estimated at the National Peoples’ Congress meeting last week at 14.3 trillion yuan ($US 2 trillion equivalent) at the end of 2023. The meeting announced a plan to provide 2 trillion yuan ($US 280 billion) each year over the next three years to help to resolve the local government hidden debt problem.
The National Peoples’ Congress also announced additions to the earlier special stimulus bond program and some reduction in home mortgage interest rates. While the stimulus measures announced by the authorities over the past couple of months are substantial, they do not cut to the heart of the problem of too little spending and too much saving by China’s consumers. China’s growth outlook looks better than it did with the stimulus measures, but not much better as China may face a significant build up in US trade restrictions in 2025 hurting its export trade.
So, a big week in the US and China has some implications for Australia. An increase in international trade protection in 2025 led by the United States will present a head wind to growth in Australian exports. Australia could become a preferred market for Chinese exporters so the prices of imported goods in Australia may not rise as much as US imported goods prices. Nevertheless, the boost to global growth prospects from stronger US and Chinese growth prospects in 2025 still points to some upward pressure from import prices on Australian prices.
Last week was also a big one for Australia on the economic front with the RBA leaving the cash rate unchanged at 4.35% and providing its latest economic forecasts that confirmed that an interest rate cut is a mid-2025 possibility but that it will be a shallow rate cutting cycle beyond. The cash rate assumption contained in the RBA’s November Monetary Policy Statement is one 25bps rate cut to 4.10% by end-June 2025 and then over the next year to end-2026 only another 60bps of rate cuts to 3.50%.
Essentially, the RBA still expects Australian inflation to get down slowly to the mid-point 2.5% of the 2-3% target range by the end of 2026. It does not need to wait until then before cutting the cash rate, but it needs to be certain based on data releases over the next 3-6 months that an end-2026 2.5% y-o-y CPI and underlying inflation rate are firmly in play. The RBA’s latest economic forecasts appear to us to underestimate likely domestic demand and wage growth given the tightness still showing in the local labour market. This week, the releases of the Q3 wage price index (consensus forecast +0.9% q-o-q, +3.6% y-o-y) and October labour force report (consensus forecasts of employment +25,000 and unemployment rate 4.2%) could make the RBA’s forecasts of wage growth down to 3.4% y-o-y at end-2024 with the unemployment rate up to 4.3% unlikely.
Yet the RBA needs imminent signs of weaker wage growth and rising unemployment to make it possible for inflation to fall to 2.5% y-o-y over the next two years. Add the influence of US President-elect, Donald Trump’s likely economic policy program adding to inflation pressure everywhere including Australia from late-2025 and we see significant upside risk building for the RBA’s latest inflation forecasts from late-2025 through 2026. The RBA may still have some leeway to cut the cash rate in mid-2025, but we now see the rate-cutting cycle being shallow and a possible return to cash rate hikes late in 2026 or in 2027.