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Answers to topical economic questions
So much has been happening domestically and globally lately. The list includes the Australian Federal Budget and election announcements, Trump tariff proclamations, US Federal Reserve monetary policy announcements, and a perennial concern over the Chinese economy. This week we thought to pose five questions that no doubt will be discussed throughout the nation - at work, at business lunches and at dinner parties. Please find below, our answers to these topical questions.
1. How sustainable are Australia's public finances?
Structural budget deficits for a decade, as projected by Treasury, are not sustainable as it places Australia’s public finances on a knife edge and vulnerable to negative shocks to the economy. There are many problems created by running deficits for such a lengthy time, not the least being the rise and rise in government debt. Apart from keeping interest rates high, rising government indebtedness will eventually call into question our fiscal competency and, potentially, the willingness of foreign investors to provide capital at reasonable rates of return.
2. How many cuts do you expect from the RBA and what will the be the main drivers?
We expect just one more rate cut this year from the RBA. A gradual softening in the labour market, combined with increasing confidence that inflation is approaching the mid-point of the target band, will allow the RBA to continue its easing cycle. However, high unit labour costs due to weak productivity growth and a post-Covid increase in the neutral rate (the rate the RBA would set if inflation were at its target of 2.5% and the unemployment rate was around 4¼%) will limit the easing cycle to one more rate cut.
3. What is the outlook for the Chinese and US economies this year? How is Trump's aggressive tariff agenda affecting the outlook?
The US economy is slowing to below trend growth and Chinese growth will disappoint authorities coming in below their target of 5%. We have been revising both our US and China growth rate forecasts due to the Trump tariff agenda. Interestingly, we have revised our US forecasts down, but our China forecasts have been revised up.
In the US, higher tariffs weigh on growth through higher costs, higher inflation and potentially higher interest rates. In China, US tariffs have forced policy makers to increase fiscal and monetary policy support to an economy that was already struggling with cyclical and structural headwinds.
4. How far will China go to stimulate its economy and will the measures support the demand for Australian exports?
China will do whatever it takes to stimulate its economy and avoid an extended recession. While the stimulus will be targeting the Chinese consumer, its effect will inevitably lead to higher demand for steel through higher levels of manufacturing production and infrastructure investment. Although this will benefit prices for iron ore and coking coal and boost Australia’s terms of trade, the impact will be less than in the past as Chinese authorities lean more heavily toward support of consumer spending than infrastructure and the property market.
5. Do you agree with the Fed that tariffs will be transitory?
Whether the Fed can treat tariffs as transitory will depend on a number of factors including: the size and timing of tariffs; amount of slack in the US economy; and whether trading partners reciprocate. Our view is that the US effective tariff rate is headed towards 15% by the middle of this year, up from 2.3% in 2024. Our modelling suggests this would cause the US price level to rise by 1 percentage point, lifting US PCE inflation to around 3% by the end of 2025. This is the upper limit that the Fed would be able to tolerate as temporary, as anything beyond this risks a blowout in inflation expectations. If inflation expectations began to drift higher, the risk of a price/cost spiral would dramatically increase as businesses and workers began to factor in ongoing high inflation rates into their price and wages settings, respectively.