Monthly inflation update, plus trade lessons from Trump 1.0

The main Australian data release this week was the monthly Consumer Price Index (CPI) indicator for January 2025. The headline rate was up 2.5 per cent over the year, unchanged from December 2024 and below the market consensus forecast of 2.6 per cent. Underlying inflation as measured by the annual trimmed mean rose from 2.7 per cent in December to 2.8 per cent last month.

There are more details on the release below but taken overall, there was nothing in the monthly numbers that should cause the RBA to second guess its decision to deliver a rate cut last week. Underlying inflation ticked up a little but remained in the target band. Headline inflation was slightly softer than the market expected. Equally, that same nudge up in underlying inflation means there was little here (aside from some positive news on easing housing-related price pressures) to hasten a second rate cut.

The new RBA Monetary Policy Board begins operations from 1 March this year and will announce its next interest rate decision on 1 April. Before that rolls around, the board will see new data on January 2025 retail trade (on 4 March), December quarter 2024 GDP (5 March), the February 2025 labour force (20 March) and the February 2025 Monthly CPI indicator (26 March).

Elsewhere, this week brought another threat of tariffs from the Trump administration, with the US president threatening to impose 25 per cent tariffs on the EU. The list of tariff proposals continues to lengthen, although at this stage only one (additional 10 per cent tariffs on China) has taken effect. Proposed 25 per cent tariffs on Mexico and Canada (with 10 per cent tariffs on Canadian energy exports) are on hold until 4 March this year; 25 per cent tariffs on steel and aluminium are due to come into force on 12 March; and the administration’s ‘Fair and Reciprocal Plan’ is apparently scheduled to start operating from 2 April. Separately, Trump has flagged sectoral tariffs on automobiles, semiconductors and pharmaceutical products. At this stage, it’s not clear how many of these proposals are overlapping or which ones will eventually go ahead. Below, we review some lessons from the trade and tariff wars that occurred during the first Trump presidency (Trump 1.0).

In this week’s Dismal Science podcast, we briefly review this week’s inflation numbers before digging into the drivers of a new Age of Uncertainty for businesses and policymakers.

Finally, a reminder that the AICD is supporting The Australian Financial Review Director Awards 2025, celebrating Australia’s top directors for their impact on strategy and sustainable growth. Nominate a director or yourself by 6 March 2025.

Monthly headline inflation unchanged in January

According to the ABS, the monthly Consumer Price Index (CPI) Indicator rose 2.5 per cent over the year to January 2025. That was unchanged from the December 2024 reading but represented a slightly better outcome than the market had expected – the consensus forecast was for a 2.6 per cent print.

The ABS said the largest contributors to the annual movement in the CPI indicator were Food and non-alcoholic beverages (up 3.3 per cent), Housing (up 2.1 per cent) and Alcohol and tobacco (up 6.4 per cent).

According to the bureau, the increase in annual food inflation was mainly driven by Fruit, with prices 12.3 per cent higher compared to a year ago. Berry prices are elevated due to poor growing conditions in mid-2024, while a more recent increase in prices for avocados, mangoes and citrus fruit reflects lower supply during the summer growing season.

Within the Housing group, electricity prices fell 11.5 per cent over the year, marking a significantly smaller drop than December’s 17.9 per cent decline. The ABS said this reflects the impact of increases in electricity prices for  Queensland households that had used up their State government’s electricity rebate (Queensland had announced a one-off rebate of $1,000 from July 2024 which exceed the average electricity bill for the state – but by January some households had exhausted its’ full value). Elsewhere in the Housing group, annual inflation for rents eased from 6.2 per cent in December to 5.8 per cent last month on the back of rising vacancy rates. The rate of price increase for new dwellings slowed from 2.3 per cent to two per cent, with the latter marking the weakest annual rise since June 2021 as home builders offered incentives and promotional offers.

Automotive fuel prices fell 1.9 per cent in the 12 months to January, following a 1.4 per cent annual fall to December.

While headline inflation was steady last month, underlying inflation nudged upwards as the rate of increase in the annual trimmed mean (which excluded the annual fall in electricity prices) ticked up from 2.7 per cent in December to 2.8 per cent.

The CPI, excluding volatile items (fruit and vegetables and automotive fuel) and holiday travel inflation rate also edged higher last month, rising from 2.7 per cent to 2.9 per cent.

New weights for the CPI

The ABS has conducted its annual update to the weights for the Consumer Price Index (CPI) and Living Cost Indexes (LCIs).

After the update, the Housing group (21.39 per cent) retains the largest weight in the CPI, followed by Food and non-alcoholic beverages (17.44 per cent), Recreation and Culture (12.74 per cent) and Transport (11.45 per cent).

Noteworthy changes included:

• A 0.44 percentage point decline in the weight for the Alcohol and tobacco group thanks to a decline in sales of legal tobacco products;
• A 0.35 percentage point decline in the weight for the Housing Group, due to the impact of falls in the weight for new dwellings purchases (down 0.48 percentage points reflecting dwelling commencements in 2023-24 slumping to their lowest rate in more than a decade) and for electricity (down 0.52 percentage points due to the impact of government rebates) that were only partially offset by a 0.58 percentage point increase in the weight for rents;
• A 0.41 percentage point decline in the weight for Furnishing, household equipment and services reflecting lower spending on discretionary goods;
• A 0.35 percentage point increase for the Education group because of the joint impact of higher education fees and higher enrolments at non-government schools;
• A 0.3 percentage point increase in the weight of the Health group due to an increase in the number and cost of medical services.

Trade and tariff lessons from Trump 1.0

As the global economy grapples with the consequences of the new US administration’s aggressive approach to trade policy, it is useful to look back at what we might learn from Trump 1.0.

During his first administration, President Trump launched a series of tariff measures. They began in early 2018 with tariff increases on washing machines and solar panels and were followed by additional tariffs on steel and aluminium. But the main target of Trump 1.0 was China, with Washington and Beijing engaging in a sequence of tit-for-tat trade measures that escalated over 2018 and 2019, before the two sides brokered a ceasefire in their trade war in the form of the January 2020 US-China Phase One Agreement.

During this period, each country increased its average duty on imports from the other to around 20 per cent, with more than 50 per cent of bilateral trade affected. It has been calculated that by the share of GDP targeted by tariffs and by the share of products subject to tariffs, the US-China trade war was more substantial than the infamous 1930 Smoot-Hawley tariff. The Biden administration that followed the first Trump administration kept most of these tariffs in place. But in May 2024 it announced tariff increases on an additional US$18 billion of Chinese goods, including semiconductors and electric vehicles.

The Trump 1.0 trade war with China was seen at the time as representing one of the largest and most abrupt changes in US trade policy history. As a result, it prompted a wave of academic and other studies that attempted to gauge the impact of the shift to tariffs. See examples here, here, here and here. A good overview of initial economic research results through to 2021 is here. See also this more recent review of the lessons from US-China trade relations. There have also been related studies looking at US-China decoupling and at the shifting geography of global trade and supply chains.

So, what did we learn from that earlier bout of trade conflict? Here are 11 findings from the literature:

1. US importers seem to have borne the brunt of the tariffs through higher prices, although US retailers may have shielded US consumers to some extent by accepting lower margins. Several studies that examined the response of US import prices to US tariffs found that pass-through was remarkably high. And this result appears to have been robust across different researchers, data sources and time horizons.
2. The tariffs did raise significant revenues for the US government. For example, the Tax Foundation estimates that at the end of last year, trade war tariffs had generated more than US$264 billion of increased customs duties collected from US importers. Of that total, about 34 per cent was collected during the first Trump administration, with the balance collected during the Biden administration. Based on actual revenue collections data, the Tax Foundation reckons this is equivalent to an increased annual tax collection from US households of US$200 to US$300 per household, on average. In this context, note that the economic consensus is that tariffs are typically a highly regressive tax policy.
3. Both the United States and China suffered welfare losses from the trade war, in the form of lower real incomes. China suffered the larger losses, although in each case these effects were small, relative to GDP.
4. While industries directly protected by US steel and aluminium tariffs enjoyed a production increase, this was (more than) offset by a production decrease in downstream industries affected by higher input costs.
5. There is little evidence that the tariffs provided an employment boost to the US heartland and they could have contributed to a small fall in US manufacturing employment overall. Even so, the trade war may have delivered some political benefits to the Trump administration.
6. There is some evidence that higher tariffs pushed up costs for US exporters reliant on imported inputs, leading to lower exports.
7. On the surface, the United States has been successful in diversifying trade away from China. Between 2017 and 2024, it reduced its share of manufactured goods trade with China by six percentage points, as the latter lost US market share across almost all sectors. In the most impacted sectors (including electronics, machinery, textiles, and apparel), the share of US imports from China fell by between 14 and 16 percentage points. Importantly, however, China still managed to grow its overall share of global exports over this period, suggesting that Chinese exporters were successful in diversifying sales (as well as using transhipments to circumvent tariffs – see next point).
8. The share of US imported value added originating in China may not have fallen as much as indicated by gross trade flows, however. For example, the United States increased its share of imports from ASEAN by about four percentage points over this period (and from Mexico by two percentage points) and a significant share of the value exported by ASEAN economies to the United States turns out to have represented value added originally in China.
9. The increase in US tariffs prompted the rise of so-called connector countries such as Vietnam that have benefited from a re-routing of previously bilateral trade and investment flows through third parties.
10. Related, the US-China trade war led to a global trade reallocation that included opportunities for ‘bystander’ countries to grow their exports of tariff products not just to the United States, but also to the rest of the world.

11.Despite its tariff policy, the first Trump presidency oversaw an increase in the aggregate US trade deficit. In 2016, the year before President Trump took office, the combined deficit on goods and services was about US$479 billion, while the goods trade deficit was closer to US$770 billion (balance of payments basis). By the time of his final year in office, in 2020, the overall deficit had risen to almost US$654 billion and the deficit on goods trade had increased to nearly US$913 billion. Since then (and remembering that the Biden administration kept most of the Trump 1.0 tariffs in place), both deficits have risen further, climbing to US$918.4 billion and a record US$1.2 trillion, respectively.

Overall, then, the evidence from Trump 1.0 is broadly consistent with economic theory, which says that while tariffs can change the composition of the trade balance, they are often relatively ineffective in changing its overall size, which is driven by the balance of saving and investment in the economy. This is also consistent with larger multi-country studies on the macroeconomic consequences of tariffs, which tend to find tariffs have only small effects on the trade balance (but negative consequences for output and productivity).

What else happened on the Australian data front this week?

Total private new capital expenditure fell 0.2 per cent over the December quarter 2024 (seasonally adjusted) but was still 0.6 per cent higher over the year. According to the ABS, spending on buildings and structures was up 0.2 per cent in quarterly terms and down one per cent in annual terms, while expenditure on equipment, plant and machinery fell 0.8 per cent in quarterly terms but rose 2.4 per cent on an annual basis. By industry, business investment fell 0.6 per cent quarter-on-quarter in the mining industry and dropped 0.1 per cent in non-mining industries. At the same time, investment in data centres by the information media and telecommunications industry (up 22.3 per cent) remained strong. Businesses also revised up their planned investment spend in 2024-25 (Estimate 5) by 3.2 per cent relative to last quarter’s estimate. Estimate 1 for 2025-26 was just 1.8 per cent higher than the corresponding estimate for 2024-25.

The ABS said total construction work done rose 0.5 per cent (seasonally adjusted, volume basis) over the December quarter 2024 to be 1.8 per cent higher in annual terms. Building work was down 0.7 per cent over the quarter and the year, pulled down by falls in non-residential construction that offset a more modest increase in residential construction. Engineering work done was up 1.8 per cent quarter-on-quarter and 4.6 per cent year-on-year.

The ANZ-Roy Morgan Consumer Confidence Index jumped 4.7 points to 89.8 index points in the week ending 23 February. The lift follows last week’s RBA rate cut and means the index is now at its highest level since May 2022. All five subindices increased over the week, with the largest gains for ‘current financial conditions’ (up 7.5 points) and ‘future financial conditions’ (up 10 points). Weekly inflation expectations tumbled by 0.7 percentage points to 4.2 per cent.

The S&P Global Flash Australia PMI Composite Output Index rose to 51.2 in February from 51.1 in January, taking the index to a six-month high. The Composite Output Index has now been in positive territory for five consecutive months. The acceleration in private sector activity this month was driven by the services sector, with the Flash Australia Services PMI Business Activity Index climbing to 51.4 from 51.2 in January. In contrast, the Flash Australia Manufacturing Output Index slipped from 50.5 to 50.1 (although the Flash Australia Manufacturing PMI increased this month). At the same time, business sentiment deteriorated in both the manufacturing and services industries in February, falling to a four-month low on ongoing concerns about the economic outlook. Finally, input cost inflation rose for a third consecutive month and is back at its highest rate since last September, with survey participants citing higher material, energy, financing and wage costs. Firms were reluctant to pass these costs on in full (in line with last week’s RBA observation on falling margins), however, with selling price inflation easing this month.

Other things to note . . .

• Secretary to the Treasury Steven Kennedy’s Opening Statement to the Senate Economics Legislation Committee provides a quick overview of the state of global and Australian economies.
• From last Friday, RBA Governor Michele Bullock’s Opening Statement to the House of Representatives Standing Committee on Economics. It includes an update on upcoming changes to the central bank’s governance, with the new Monetary Policy and Governance Boards starting operations from 1 March.
• Also from the RBA, a speech from Michael Plumb, Head of Economic Analysis Department, on why productivity matters. Plumb reviewed Australia’s recent productivity performance, highlighting that annual labour productivity growth has averaged a lacklustre 0.2 per cent between 2017/18 and 2023/24, reflecting a combination of slow growth in Multifactor Productivity  or MFP (which measures the efficiency of use of production inputs such as labour, capital and energy) and slow growth in the amount of capital per worker as investment failed to keep pace with strong employment growth.
• The ABC’s David Speers analyses the message to Australia from US Treasury Secretary Scott Bessent.
• The Lowy Institute’s Sam Roggeveen considers how Australia should respond to Chinese warships’ live fire exercise.
• New experimental estimates from the ABS for National Ecosystem Accounts for Australia. In 2020-21, Australia’s terrestrial realm comprised 49 per cent of Australia, while desert ecosystems made up 50 per cent of our terrestrial landscape.
• Brad DeLong explains why the United States didn’t turn into a ‘Giant Australia’.
• According to this estimate, clean energy sectors (renewables, nuclear power, electricity grids, energy storage, EVs and railways) made up more than 10 per cent of China’s GDP in 2024 and drove a quarter of economic growth.
• A new IMF working paper on the macroeconomic effects of natural disasters.
• An FT Big Read on Apple’s pivot to India.
• Brad Setser on the iPhone, the IMF and China’s balance of payments.
• Can financial market bubbles repeat?
• The WSJ on bifurcation in the US consumer market. And on Mexico’s Sinaloa Cartel.
• Why Japan succeeds despite stagnation.
• The Atlantic Council’s Global Foresight 2025 survey overview and results.
• The Economist magazine ponders the return of inflation and (echoing the Douglas Irwin link from last week) the absurdity of reciprocal tariffs.
• RAND lists Artificial General Intelligence (AGI)’s five hard national security problems. These are wonder weapons, systemic shifts in power, the empowerment of non-experts to develop weapons of mass destruction, artificial entities with agency and instability.
• Do trade shocks explain Europe’s rightwards shift?
• The Committee for a Responsible Federal Budget estimates that the fiscal year 2025 budget resolution passed by the US House of Representatives this week could boost the US federal deficit by US$2.8 trillion through to FY2034 and add at least US$3.4 trillion to federal debt, including interest costs.
• The OECD’s Competition Trends 2025.
• Chatbots of the dead.
• The future looks ratty.
• The These Times podcast offers an early take on German election results.
• Two podcasts from the FT. On the Economics Show, Martin Wolf talks to Professor Richard Baldwin about the future of global trade. And the Unhedged podcast examines another financial market vibe shift.
• The Odd Lots podcast in conversation with Jim Bianco on the idea of a Mar-a-Lago Accord (that is, a potential Trump 2.0 version of the Plaza Accord).