Welcome back…to trade wars, policy uncertainty, new-look RBA

Welcome back to the AICD’s regular weekly economic update. It has been an action-packed start to the year for the global economy, with the past week dominated by the announcement of US tariffs on Canada, China and Mexico, quickly followed by a 30-day stay of execution for the two neighbouring countries. 

While the immediate economic implications of these events for Australia look limited, there could be more profound implications for the future of the world economy, along with a potential hit to global growth if the world is now moving into a higher policy uncertainty regime. We take a closer look at recent trade policy developments below. Closer to home, we remind readers of how the RBA’s monetary policy framework will be changing this year. We also have the usual roundup of Australian data releases, plus a selection of readings where this week’s focus is the global economic outlook for 2025.

Trade Wars, interrupted

On 1 February 2025, US President Donald Trump announced that his administration would impose tariffs on Canada, China and Mexico. According to the White House, with effect from 4 February the US would impose a 25 per cent tariff on US imports from Canada and Mexico, except for Canadian energy imports which would be subject to a lower 10 per cent tariff rate. There would also be a new 10 per cent tariff on Chinese imports, in addition to already-existing restrictions. According to press reports, there would be no exemptions to the tariffs, the US would suspend the so-called ‘de minimis’ loophole that allowed shipments worth less than US$800 enter the country duty free and the measures would come with a ‘retaliation clause’ that would increase tariff rates in response to any target country retaliation to the initial measures.

The administration said tariffs were to be imposed under Section 301 of the US Trade Act (1974) which grants authority to retaliate against other countries for unreasonable acts that burden US commerce and under the International Emergency Economic Powers Act (IEEPA), which gives the US president powers to respond to national emergencies. The declared reasons for the move were to encourage the three countries to act against flows of fentanyl and illegal immigrants into the United States.

Then, after 48 hours of chaos, the White House declared it would delay imposing tariffs on Mexico and Canada for at least 30 days, until 4 March 2025.

The tariffs on China went ahead, however, and Beijing has already responded with its own announcement of trade measures including tariffs of between 10 and 15 per cent on imports of US LNG, coal, crude oil and farm equipment; tariffs on some US car imports; and additional (non-country specific) export controls on five rare earths. Beijing also said it would launch an anti-monopoly investigation into Google.

Sizing up the impact of US tariffs

Some calculations from US trade economist Douglas Irwin suggest that if they are all fully implemented, the combined impact of the proposed tariffs on Canada, China and Mexico would see the average US tariff on all imports rise from 2.4 per cent (its 2023 level) to around 10.5 per cent – an increase of around eight percentage points. The average tariff rate on dutiable imports would rise from 7.4 per cent to 17.3 per cent – an increase of about 10 percentage points. (Irwin notes that this estimate represents an upper bound of the actual effect since it assumes no reduction in imports in response to the tariffs.)

Putting that into an historical context, the increase in the average tariff on dutiable imports would be larger than the tariff increase triggered by the infamous 1930  Smoot-Hawley Tariff (10 percentage points vs five percentage points) although the level of the average tariff rate would remain much lower (17.3 per cent vs 41.1 per cent).

At more than 10 per cent, the implied average tariff on US total imports would return to levels not seen since the 1940s, while remaining far below the kind of tariff levels seen in the late 19^th and early 20th centuries. The estimated impact is also smaller than some of the measures Trump had proposed during the presidential election campaign. The latter included promises of a 60 per cent tariff on China and a universal tariff of either 10 or 20 per cent. If implemented, that mix would imply an average tariff rate closer to 17 per cent.

In terms of the potential economic implications of this level of protection, some initial model-based estimates from economists Warwick McKibbin and Marcus Noland find that a 25 per cent tariff on all goods from Mexico and Canada would reduce economic growth and push up in inflation in both countries, as well as in the United States. According to their modelling, US GDP for the duration of the Trump administration would be around US$200 billion lower than in the absence of the tariffs, Canada would lose US$100 billion (on a much smaller national GDP), and the Mexican economy would shrink by two per cent relative to baseline.

In the case of a 10 per cent tariff on China (and assuming China responds with tit-for-tat measures), they estimate that US GDP would be US$55 billion lower over the four years of the Trump administration while China’s GDP would be US$128 billion less. US inflation would be 20bp higher and Chinese inflation 30bp higher than in the absence of tariffs.

For now, the direct implications of all this for Australia look limited. First, it is not clear whether the tariffs on Canada and Mexico will now go ahead next month. Second, it is also unclear how long the tariffs on China will remain in place. In this context, some market optimists are arguing that the episode has served mainly to demonstrate that tariff threats are mostly a negotiating tool rather than an aim in themselves. Third, the direct trade ties to Australia look limited. After all, Canada only accounts for about 0.9 per cent of our total goods and services trade (calendar year 2023 data) and Mexico for just 0.5 per cent, although the United States is more important, with a share of about eight per cent.

Of course, the critical trading partner for Australia is China, which accounts for about 26 per cent of our two-way trade and is the destination for almost 33 per cent of our exports of goods and services. A significant trade war inspired disruption to Chinese growth – and therefore to Chinese demand for Australian exports – would represent an important adverse shock and is the key risk to monitor in this context.

Broader implications of the shift in US trade policy: A big uncertainty shock

Looking beyond the specifics of the past week’s tariff announcements, we can also make three initial judgements about the broader implications of recent developments for the international economic environment.

First, 2025 will see no slowdown in the ongoing splintering of the international trading system and the fracturing of (what was left) of the rules-based international economic order. Sure, stories about deglobalisation or geoeconomic fragmentation are old hat by now, but it seems plausible that the past week’s events have moved us even further down that road. That is unwelcome news for medium-sized players (like Australia) and even more so for smaller economies, all of whom are more vulnerable to economic coercion and/or mercantilist policies than the world’s heavyweights.

Second, the rising deployment of tariffs and other trade measures undermines the economic logic of the global supply chains that characterised the previous era of hyperglobalisation. Once again, this is hardly news. But what is noteworthy here is that the threat to deploy tariffs across the North American economic area suggests that one set of proposed solutions to the challenges posed by geoeconomic fragmentation now look to be less of a risk mitigant than proponents had anticipated. These include a mix of friendshoring/nearshoring/more regional trade. So the kind of multinational operations and within-firm trade arrangements that have been a product of the previous era of liberal trade policies look increasingly ill-suited to a world which involves the frequent use of – or even the frequent threat of – tariffs and trade barriers.

Finally, the second Trump administration is manifesting as a major economic policy uncertainty shock for the global economy. Currently, this is most obviously the case for trade policy, where measures of uncertainty have reported a sharp and predictable jump. But a look at other announcements suggests that the policy uncertainty associated with the new administration is likely to go beyond trade.

In theory, this negative policy uncertainty shock should serve as a drag on economic activity. That is because the risks associated with unpredictable future policies and regulatory settings are likely to encourage businesses to postpone or review some forward-looking decisions including investments, hiring, market and product development, and so on. There could also be similar implications for household decisions. All else equal, a world of higher policy uncertainty is likely to be a world with less investment, less employment and less growth.

What might happen next?

At this early stage, it remains highly uncertain what the Trump administration is likely to do in terms of further trade policy interventions. In addition to the measures that dominated the headlines this week, over the course of the US presidential campaign and in the early days of his presidency, Donald Trump has discussed the introduction of a universal tariff of up to 20 per cent on all US imports; imposing a 60 per cent tariff on China; imposing tariffs on the EU; imposing tariffs on India and targeting members of the BRICS grouping.

One challenge in thinking about what comes next is that the motives behind current US tariff policy remain unclear, in large part because there seem to be multiple potential objectives. Tariffs – and trade policy more broadly – have variously been described as:

• A measure to target countries with which the US runs large bilateral trade deficits with the objective of restoring more ‘balanced’ trade.

• A means to restore US manufacturing prowess and/or a tool of industrial policy.

• A negotiating tool to generate a mix of economic and non-economic concessions from the targeted country, with the latter including cooperation on border enforcement (Mexico, Canada) and higher defence spending (the EU, Taiwan)

• A significant source of government revenue and as such a potential substitute for other forms of taxation.

• And a geoeconomic weapon that can target US rivals while also promoting domestic capabilities and boosting national security.

In addition, some political analysts have suggested two additional use cases for tariff threats:

• A mechanism for demonstrating US international dominance to a domestic policy audience.

• And a way of generating newsworthy deals and ‘wins’ to feed the beast that is the attention economy.

Further complicating the picture is that some of these objectives look to be contradictory. Tariffs that are deployed as a negotiating tactic are unlikely to prove a sustainable source of alternative revenue or a durable industrial policy tool, for example. Likewise, tariffs targeting US allies would seem to have uncertain implications for longer term US national security concerns. Moreover, in in at least some of these use cases there is a risk of rapidly diminishing returns to repeated use.

Meanwhile, welcome to 2025 and a new age of (trade policy) uncertainty.

New year, new RBA Monetary Policy Board

Turning from the international to the domestic, a quick note to remind readers that this month’s upcoming monetary policy meeting (17-18 February) will be the last to take place under the RBA’s existing structure. The Government’s response to the recommendations of the 2022-23 Review of the RBA were legislated in late November last year and included measures to replace the existing Reserve Bank Board with a new Monetary Policy Board (MPB) along with a separate Governance Board.

The new MPB is scheduled to commence operations from 1 March this year. It will have nine members including six external members (Ms Marnie Baker, Ms Carolyn Hewson AO, Professor Ian Harper AO, Professor Renee Fry-McKibbin, Dr Ian Ross AO, and Mrs Alison Watkins AM) as well as the RBA Governor and Deputy Governor, and the Secretary to the Treasury. Of the six external members, four (Harper, Hewson, Ross and Watkins) currently serve on the existing RBA Board while two (Baker and Fry-McKibbin) are new appointments made by the Treasurer in December last year. The new MPB’s first decision on the cash rate target will come with the second policy meeting of this year, to be held over 31 March-1 April.

We will return to the RBA next week with a detailed look at the case for a rate cut on 18^th February in what will be the last meeting under the ‘old regime’.

What happened on the Australian data front this week?

The ABS said Australian retail sales fell 0.1 per cent over the month (seasonally adjusted) in December 2024, to be up 4.6 per cent over the year. That was a stronger result than markets had expected (the consensus forecast was for a 0.7 per cent monthly fall) which the Bureau suggested reflected retailers’ promotional activities that stretched across the whole of the fourth quarter last year (including Cyber Monday which fell in early December) and which boosted household spending on furniture, homewares, electronics and electrical items. In volume terms, total sales rose one per cent over the quarter. More notably, per capital retail spending rose 0.5 per cent, marking the first rise in per capita terms since the June quarter 2022.

Related, the ABS Household Spending Indicator (HSI) rose 0.4 per cent over the month (seasonally adjusted) in December 2024 to be up 4.3 per cent over the year. According to the Bureau, five of the nine spending categories covered by the indicator rose over the month, with spending on discretionary goods and services – including new vehicle purchases, dining out, air travel and streaming services – helped drive growth, as consumers took advantage of end of year sales. Discretionary spending has now risen for three consecutive months. In volume terms, the December quarter 2024 HSI was 1.4 per higher over the year.

CoreLogic’s National Home Value Index (HVI) was little changed in January 2025 (down by less than 0.1 per cent over the month and up 4.3 per cent over the year). The combined capitals index fell 0.2 per cent over the month, pulled down by monthly falls in Melbourne (down 0.6 per cent), the ACT (down 0.5 per cent) and Sydney (down 0.4 per cent). But it was still up 3.8 per cent in annual terms. Overall, the national HVI has now fallen 0.3 per cent from the record highs recorded in October 2024, with CoreLogic commenting that ‘with the first rate cut likely to be imminent’, the housing downturn could prove to be a shallow one. Rental growth showed some acceleration in January following a soft H2:2024, with rents up 0.4 per cent over the month and 4.4 per cent higher over the year. Overall, however, CoreLogic still reckons that ‘the trend is clearly pointing to an ongoing easing in rental price growth’.

The number of total dwellings approved rose 0.7 per cent to 15,174 (seasonally adjusted) in December 2024 to stand 12.2 per cent higher than in the same month in 2023. According to the ABS, approvals for private sector houses were down in both monthly and annual terms at 8,715, but this was more than offset by a 15.2 per cent monthly jump in approvals for private sector dwellings excluding houses to 6,209, representing a 42.7 per cent increase in annual terms. In total, 171,394 dwellings were approved across the whole of last year, up from the 163,722 approvals in 2023. That total remains well below the 240,000 new homes a year required to meet the National Housing Accord’s target of 1.2 million new homes by 2029.

The ABS published December quarter 2024 updates to its five Selected Living Cost Indexes (LCIs). Over the past year, the annual rate of increase ranged from a low of 2.5 per cent (for the Age Pensioner and Self-funded retiree LCIs) to a high of four per cent (for the Employee LCI). The latter continues to reflect the impact of higher mortgage interest charges which were up 14.7 per cent over the year, as although there was no change in the cash rate last quarter, the combined impact of higher debt levels and the ongoing rollover of expired fixed rate mortgages to higher variable rates pushed up costs. By way of comparison, the annual rate of increase in the Consumer Price Index (CPI), which does not include mortgage interest payments, was 2.4 per cent over the same period. LCIs in the fourth quarter were influenced by lower electricity prices due to Commonwealth Energy Bill Relief, an increase in Commonwealth Rent Assistance and an increase in the share of government payment recipient households reaching the Pharmaceutical Benefits Scheme (PBS) safety net.

ANZ-Indeed Australian Job Ads rose 0.2 per cent over the month in January 2025 (seasonally adjusted) but were down 15.1 per cent compared to their level in January last year. Still, the series has now risen 0.5 per cent over the past two months to be 1.3 per cent higher than its August 2024 low, with ANZ noting that the Job Ads series looks to have stabilised at a level that is around 15 per cent above its pre-pandemic average.

The ANZ-Roy Morgan Consumer Confidence Index rose 2.5 points to an index reading of 88.5 for the week ending 2 February 2025. That marks the highest weekly reading since May 2022, with the short-term economic confidence subindex up to its highest level since April 2022 and the economic confidence over the next five years subindex at a 12-month high as households anticipate an RBA rate cut this month. Weekly inflation expectations fell to 4.6 per cent, a drop of 0.4 percentage points.

Australia’s goods trade balance fell by $1.7 billion in December 2024 to a surplus of just over $5 billion (seasonally adjusted). Goods exports were up $0.5 billion while goods imports rose by $2.2 billion, with the latter driven by imports of capital goods.

New ABS data on barriers and incentives to labour force participation in Australia.

Other things to note . . .

• The January 2025 RBA Bulletin is available and includes pieces on the household cash-flow channel of monetary policy, disappearing economics students, and China’s post-pandemic policy priorities.
• Also from the RBA, a new research paper investigates the effectiveness of investment tax breaks (ITBs). The authors examine several ITBs introduced over the past two decades and reach three main conclusions. First, they find that the ITB used during the GFC did lead to a significant increase in investment. But they also find that other ITBs, including those implemented during the COVID-19 pandemic, did not have a significant impact. Second, they find that unincorporated businesses are more responsive to ITBs than incorporated companies. Third, they also find some ‘very tentative evidence’ that the corporate tax cut for small businesses delivered in the 2010s did lead to some additional investment.
• CoreLogic on forces shaping the Australian housing market in 2025.
• Ahead of this year’s Federal election, the Grattan Institute runs its eye over new data on political funding in Australia.
• The Business Council of Australia (BCA) sets out its priorities for the 2025 Federal Election. The proposals are based around five big challenges: Easing the cost-of-living crisis, tackling the housing crisis, achieving net zero by 2050 with affordable and reliable energy, developing a skilled workforce and delivering health and care services.
• On duelling estimates of the Coalition’s tax-free business lunch
• Is Australia’s middle class shrinking?
• A short summary of the Deloitte Access Economics Australian Business Outlook for 2025.
• The latest official views on the outlook for the world economy: the IMF’s January 2025 World Economic Outlook Update and the World Bank’s January 2025 Global Economic Prospects.
• Related, a BIS Bulletin on completing the post-pandemic landing.
• Another from the IMF, how to measure the monetary stance.
• According to the World Economic Forum’s Global Risks Report 2025, State-based armed conflict is now ranked as the #1 current global risk for 2025 by 23 per cent of respondents, ahead of extreme weather events (14 per cent) and Geoeconomic confrontation (eight per cent).
• Two Big Reads from the FT: one on the United States, China and global AI race; the other on Trump’s new economic war (this second one predates the recent moves over Canada-China-Mexico tariffs).
• And two new reports from the McKinsey Global Institute. The first looks at the demographics of depopulation, the second provides a 2025 update on geopolitics and the geometry of global trade.
• The WSJ’s Greg Ip on Trump, tariffs, and trade wars.
• This analysis of the relationship between tariffs and inflation argues that it is more complex than the simple claim that ‘tariffs are inflationary.’
• Why demographics do not predict US election outcomes.
• This week’s Economist Magazine has a special briefing on the war on red tape, arguing that deregulation could significantly boost economic growth.
• Nat Bullard’s annual presentation on the state of decarbonisation.