Break in trade storm still leaves job for RBA

Sydney’s central business district. The mood in the markets is for the RBA to cut interest rates aggressively at its next meeting in May. Picture: AFP

Sharemarkets around the world have rallied after the Trump White House hit pause on elements of its plan to raise tariffs on a broad front, but the scars inflicted on markets and corporate confidence since “Liberation Day” are still raw, and the problems are far from resolved.

For manufacturers now surveying the wreck of global supply chains and the money-market investors who have seen their wealth decimated, it might still feel like they are living out a game of Whac-A-Mole.

Subject to a social media post or further reprisals, just when and where the next blows to certainty and confidence will come still can’t be predicted. While that is the case, investment and new-job creation will struggle, and growth in the world economy will slow.

For central banks worldwide, which are still shaping up to deal with the twin evils of rising prices and stalling growth, it is a vexing time that none of them would have anticipated at the start of the year when they were otherwise celebrating tamed inflation and economic recovery.

Make no mistake, Washington’s decision this week to suspend hostilities on parts of its trade policies was forced by financial markets. While plunging share prices were the visible face of the recent crisis, US government bond yields also soared amid fears that big investors, which included China, were starting to abandon the market.

The chaos around trade policy, and the Trump administration’s apparent high level of tolerance for investor pain, started to erode faith in US economic management at a deeply fundamental level, sending yields sharply higher.

Government bond markets are the plumbing of the world economy, and when yields soar, as they did on Wednesday (US time), it suggested that things were headed for dysfunction and another big leg down in markets, finally forcing the White House’s hand.

For the Reserve Bank of Australia, the policy needle is now pointing firmly to cutting interest rates at its next board meeting in late May. Increasingly, the mood in markets is for the RBA to cut by 50 basis points as it moves to catch up with events in the world economy after it sat on its hands at its April Fool’s Day policy meeting.

Sally Auld, the newly appointed chief economist at National Australia Bank, forecasts a 50-basis-point reduction in May, with the RBA set to continue taking the rates lower through the remainder of the year and into early 2026. Other major bank economists also expect a similar cut next month amid concerns that Australia won’t avoid the pain of the trade war.

The RBA has the ammunition to respond and should use it, given that China and trading partners elsewhere in Asia are still in the crosshairs of Trump’s tariffs. Following the May cut, Auld forecasts smaller follow-up reductions in July, August, November and February, taking the official cash rate down to 2.6 per cent.

“Much has changed since the RBA board last met in early April. Risks to both global and domestic growth have shifted to the downside,” Auld said. “Against this backdrop, a restrictive policy stance in Australia is no longer appropriate.

“The RBA needs to play catch-up.”

Australia isn’t immune from the indirect effects of the trade war, with consumer and business confidence still at risk, Auld said.

The impact on national income and wealth from weaker commodity prices and financial-market volatility will also weigh on the economy.

“Managing the risks associated with each of these channels argues for a shift to a more pre-emptive policy response by the RBA,” she said.

While the recovery in markets since the tariff pause was announced is welcome, there is still a lot of downside for markets.

David Bassanese, chief economist at BetaShares, said the global economy, particularly the US, still faces enormous risk in the weeks and months ahead.

While equity markets have bounced, this may well be but one of the several “cruel bear-market rallies” in what had become a very oversold market, he said.

The Wall Street Journal