Global agencies have significantly downgraded world economic growth, and as a trading nation heavily dependent on commodity exports, Australia is particularly vulnerable.
The OECD’s latest report downgrades global growth expectations and increases projections for inflation in the wake of the “uncertain policy environment”.
It was followed by a franker and more bearish forecast and commentary from Fitch Ratings. “The new US administration has started a global trade war that will reduce US and world growth, push up US inflation and delay Federal Reserve rate cuts,” it says.
The firm has cut its growth forecast for the US economy from 2.1 per cent in its Global Economic Outlook released in December to 1.7 per cent now, and lowered its forecast for 2026 from 1.7 per cent to 1.5 per cent.
This is well below trend and down from annual growth rates of almost 3 per cent in 2023 and 2024.
It has downgraded its expectations for world economic growth from its projection of 2.9 per cent last December to 2.3 per cent, reflecting reductions in growth in both developed and emerging economies. It expects global growth to remain weak at 2.2 per cent into 2026.
While US President Donald Trump was elected on a platform of imposing tariffs, there was initially a view that when he got into the job, he might take a more measured approach.
That hope has now evaporated. The viciousness of his attacks on allies, threats of retaliation against countries taking action against his tariffs and new concerns about global security, which will pressure defence budgets, have shocked markets.
Fitch declared that “the size, speed, and breadth of US tariff hike announcements since January is staggering”.
“The US effective tariff rate has already risen to 8.5 per cent from 2.3 per cent in 2024 and is likely to rise further.”
Fitch is expecting growth in the Eurozone to be a lot weaker than it forecast less than three months ago, despite fiscal stimulus measures in Germany, while it expects that Mexico and Canada will experience technical recessions given the scale of their US trade exposures.
It has cut the forecast for Mexico by 1.1 percentage points and Canada by 0.7 percentage points.
Its forecasts are based on the assumption of a 15 per cent effective tariff rate imposed on Europe, Canada, Mexico and others in 2025, and 35 per cent on China.
This will push the US effective tariff rate to 18 per cent – the highest rate for 90 years. But if a tariff war breaks out, effective rates could be higher.
Other elements of uncertainty for the US economy will be the potential retaliation against US exporters, with consumers in Canada and other countries starting to spurn US products.
“There is huge uncertainty about how far the US will go and our assumptions could be too harsh,” Fitch admits.
“But there are also risks of a larger tariff shock, including from an escalating global trade war.”
While Chalmers’ budget will have to take into account lower global growth expectations, the other area of concern is the increased inflationary pressure as a result of the global tariff wars and how that plays out in the Australian economy.
Further “cost of living measures” are expected in the budget on top of last year’s electricity bill subsidies.
In the US, the initial inflationary impact will be on consumers who will soon be faced with a much higher cost of goods, with major retailers such as Walmart heavily dependent on imported goods, particularly from China.
Trump’s strategy is import substitution – that his tariffs will provide a boost to US manufacturing by encouraging American consumers to choose locally produced goods. While this may play out to some effect in the longer term, in the short term it will lead to higher prices, lower real wages and increased costs for US companies.
Fitch’s expectations are that the initial impact of tariffs will add one percentage point to near-term inflation in the US.
The real question is whether this could delay the Federal Reserve board’s interest rate cuts – currently scheduled for two 25 basis point cuts by the end of the year.
The recent Federal Reserve Board’s Open Market Committee meeting held rates steady and downgraded its expectations for US growth in 2025 from 2.1 per cent in December to 1.7 per cent. It raised its projections for the personal consumption expenditure price index from 2.5 to 2.8 per cent.
In his press conference after the meeting, Fed chairman Jerome Powell said the tariffs were a major factor behind the higher inflationary outlook but was at pains to play down concerns about the long-term inflationary impact, calling them “transitory”.
Powell’s comments were clearly designed to calm nervous markets, but whether he can quell consumer and market uncertainty remains to be seen.
Commenting on the US outlook after the Fed press conference, Westpac economists warned that the “risks remain skewed to the downside”.
GSFM investment specialist Stephen Miller raised the prospect of a “stagflation lite” scenario in the US, pointing out that persistent inflationary pressures will restrict the ability of the Fed to cut rates in the face of a sharper economic slowdown.
“In the past, quiescent inflation has allowed the Fed to respond with alacrity to downdrafts in growth,” he said.
“In the current environment, however, ‘sticky’ inflation has robbed the Fed of the flexibility to quickly cut rates, a flexibility that it enjoyed in the two decades or more leading up to the pandemic.
“And with a budget deficit approaching 7 per cent of GDP, fiscal policy is close to maxed out.”
Miller raises the spectre of the US moving into recession, pointing out that the latest projections from the Atlanta Fed are for a negative 1.8 per cent growth rate for the March quarter.
In Australia, the Reserve Bank has been cautious about cutting rates, trimming the cash rate by only 25 basis points in its last meeting, with governor Michele Bullock warning that she had no plans to rush into any more cuts without more evidence of inflationary pressures easing.
Fortunately for Chalmers, the next meeting of the central bank will be the week after the budget.
The potential inflationary effects of tariff wars will confirm Bullock’s wait-and-see approach.
But her comments after the next board meeting on the global outlook for inflation and what it means for RBA policy will be closely watched for their domestic impact in the pre-election period.
Her message is unlikely to offer any joy in the short term for those with mortgages.
If US inflation rises and the Fed is slower to cut rates, it will also undermine the argument that the Australian central bank is out of step with other central banks in not cutting rates more aggressively.
Cushioning the impact of Trump’s moves has been announcements of fiscal easing in two major economies – Germany and China.
Both have been expecting the US tariffs for some time. Germany has pivoted to fiscal stimulus, which could help its economy, and the Chinese government last week announced a package of measures aimed at boosting consumer spending.
The impact of Trump’s tariffs on the Chinese economy will be important for the Australian economy. China is our largest trading partner and a key market for iron ore, LNG, coal, beef, wine, wool and other goods. Its demand sets global prices for some of Australia’s key exports.
So far the iron ore price has held up surprisingly well despite concerns about the soft Chinese economy.
Taking a more upbeat approach than Fitch, economists at ANZ recently revised its GDP forecast for the Chinese economy from 4.3 to 4.8 per cent for 2025 and from 4 to 4.5 per cent for 2026.
The bank’s economists point to the economic data for the first two months of 2025, which they say shows the positive momentum evident towards the end of last year continuing.
Part of the boost in activity towards the end of 2024 was US importers rushing to stock up on Chinese goods ahead of the tariffs.
ANZ’s more positive approach is partly driven by confidence in stimulus measures by Chinese authorities, who have been bracing for Trump’s tariff onslaught for some time.
They predict that “fiscal resources will be allocated more to policy areas that will generate more jobs, including support to the private sector”.
Economic analysts recently began dissecting 30 consumption-boosting measures announced by Beijing.
ANZ economists say concern about weakness in the services sector in China will encourage more measures to boost employment this year.
They argue that measures announced recently differ from announcements in previous years “which were only a collection of sector subsidies or just verbal guidance”.
The measures include a “trade-in program” that provides incentives for consumers to trade in their old goods to buy new ones.
ANZ economists estimate that the latest program will add another three trillion yuan ($650bn) to retail sales.
They point out there has been “a slight improvement in sentiment for the property market”, one of the weakest areas of the Chinese economy in recent years, with more cities reporting an increase in home prices since September and new home sales increasing by 8 per cent over the lunar new year holiday.
While they are not expecting to see a full recovery in the property market, they argue that the performance of the market in 2025 will be better than last year.
“Pending the economic performance in March and the rest of H1, we project that China’s GDP will stay above 5 per cent in H1, extending the solid momentum in Q4 2024.”
They also add a note of caution about the impact of Trump’s tariffs, which they warn will not only impact China’s demand for exports to the US but also other key markets in ASEAN.
Another Trump policy impact globally and domestically will be business uncertainty and how it affects plans for investment.
Fortunately for the Treasurer, this will take some time to play out. Jim Chalmers would have hoped to be delivering a pre-election budget in less uncertain times.
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