RBA Minutes reveal Donald Trump’s tariffs dominating central bank’s deliberations ahead of May cut

Donald Trump continues to hold the world in the palm of his hand, with the Reserve Bank admitting their decision on interest rates was dominated by discussions on the impact of a global trade war.

Given the constantly changing status of tariffs in the US, including legal stoushes, tit-for-tat tariff hikes and bilateral exemptions, following April 2’s Liberation Day, central bank forecasters must be at their wits’ end.

In cutting interest rates by 0.25 per cent to 3.85 per cent last month, the RBA revealed it had conducted scenario analysis to assess the potential economic fallout of a trade war.

The Minutes depict a Board reassured that inflation is sufficiently contained to justify a modest rate cut. The decision was also supported by signs of a weakening global economy, prompting the Bank to downgrade its growth and employment forecasts.

“Uncertainty” features 21 times in the RBA minutes, and that uncertainty seemed to partly stay the RBA’s hand from cutting further.

“The prevailing global policy uncertainty led members to express a preference to move cautiously and predictably when withdrawing some of the current policy restriction,” the Bank wrote, describing its wait-and-see approach as a “a path of least regret”.

The Minutes coincided with a speech to the Economic Society of Australia by the RBA’s deputy governor, and lead economist, Sarah Hunter.

“What happens overseas matters for the Australian economy and is therefore a key factor in monetary policy settings,” she said.

Economic forecasting has rarely been more complex, as Ms Hunter described the range of possible outcomes a trade war could unleash.

In one scenario, weaker global growth would create downward pressure on the prices of globally traded goods. For tariff-free countries like Australia, “this could flow into import prices, making products cheaper and lowering inflation”.

So far, so good. But the alternative is a world where “export bans could create a new bout of supply chain disruptions”, limiting access to commodities, machinery, or components.

“This could push up consumer prices in all countries, particularly for more complex products, such as cars, whose components are sourced from a wide range of countries,” Ms Hunter said.

The interconnected nature of the global economy means that a trade war can exert simultaneous forces that can erode economic growth.

Financial markets, ever forward-looking, are the first to respond to global shocks.

Ms Hunter references the sharp fall in equities, that have now rebounded. She also notes the increasing nervousness of the bond market, whose attitude to risk affects global interest rates.

Rising uncertainty prompts consumers and businesses to delay spending and investment decisions.

“If this were to occur, it would lead to a more sustained tightening in financial conditions, which would make it more expensive for businesses in particular to borrow or raise funds for investment,” Ms Hunter said.

“Increased borrowing costs and risk premia in global financial markets are likely to spill into domestic markets, further weighing on activity.”

“There is ample research showing that higher uncertainty can lead to declines in investment, output and employment. Typically, higher uncertainty leads firms to delay decisions that are costly to reverse, like investment and hiring.”

Commodities a continued strength

While financial markets, businesses, and households are vulnerable to external shocks, Australia’s commodity powerhouse is expected to be a rare bright spot in this global turmoil.

Resources make up 75 per cent of Australian goods exports, and the Bank expects China and other resource intensive countries to maintain demand, with “export volumes to remain resilient in the short run.”

“This is because Australia’s resource export volumes are less sensitive to movements in global demand than other exports as we are a relatively low-cost producer of bulk commodities like iron ore,” Ms Hunter said.

“Short-run declines in commodity prices tend to lead to reduced volumes from other higher cost producers, while Australian producers feel the impact via lower prices and... earnings.”

That resilience relies on China propping up its economy via stimulus under a scenario where both the US and China sign off on a mutually-agreed tariff level. If they do not, and there is an increasingly escalating trade war, then “income flows from commodity exports would fall significantly.”

Support for further rate cuts

For now, the tariff turmoil appears to be settling in the right direction. The US courts might still strike down Donald Trump’s authority to introduce them at all, and the President seems willing to negotiate more sensible deals, as he done with the UK, and in implementing 90-day pauses with the like of China and the EU.

But he is also still prone to wild swings in mood. Not long after a reporter asked him about suggestions he was a “TACO President”, meaning Trump Always Chickens Out, Mr Trump declared he would double the tariff on steel and aluminium from 25 per cent to 50 per cent.

If the worst excesses of Trump’s anger can be avoided, the RBA will have room to focus on the domestic situation.

And on that read, a rate cut might be needed. The latest figures show Government spending has dropped, student numbers have eased, as has trade. Retail spending and business investment has also weakened.

That would flow through to Wednesday’s GDP figures, and reflecting the economic uncertainty, a July rate cut is “live” for AMP’s Shane Oliver, but unlikely for Westpac’s Luci Ellis.