Trade, Tariffs and the Interest Rate Outlook

Key points:

• Trade deals are in progress, with a likely endpoint 10% base tariff on many countries, and potentially higher rates for perceived trade transgressors and on certain goods. While these rates are lower than initial US “Liberation Day” rates, they remain considerably higher than previously and therefore potentially dampen global trade.
• The US Federal Reserve is navigating a complex economic landscape, balancing the contractionary effects of tariffs, higher unemployment and higher prices. With the US economy performing well and unemployment low, despite the added uncertainty, the US Federal Reserve’s Open Market Committee (FOMC) is maintaining a cautious stance, awaiting clearer economic signals before adjusting interest rate policy further.
• The Reserve Bank of Australia (RBA) is expected to announce a further 25bps interest rate cut on Tuesday May 20, reflecting ongoing progress in reducing inflation and to modestly counter the risk current tariff policy uncertainty has on growth in Australia.

 

US Trade and Tariff Deals Rolling Out, 10% Minimum Tariff Emerges as Likely Baseline

The first wave of trade negotiations is underway, with the UK securing a broad-based 10% reciprocal tariff rate, alongside exemptions for key goods like steel and aluminium. This early agreement sets the stage for a minimum 10% tariff on exports from Australia and many other trading partners, with potentially higher rates for products deemed sensitive or from perceived trade transgressors.

US-China initial negotiations also resulted in reductions in tariffs from unsustainable levels of 145% (US on China) and 125% (China on the US) to 30% and 10% respectively, for the next 90 days.

While a 10% base tariff may seem moderate compared to the extreme levels initially proposed, it still represents a significant increase—more than triple previous norms. This baseline rate, coupled with targeted higher tariffs on select goods, means the overall average tariff burden remains elevated.

It’s important to remember that tariffs are taxes on residents of the country imposing the tariff, raising costs for their businesses and consumers alike. This can have a contractionary effect, slowing economic growth, while also driving up prices, potentially triggering further inflationary pressures.

 

The US Federal Reserve Adopts Wait-and-See Approach Amid Tariff Uncertainty

The FOMC, the US central bank’s monetary policy making body, signalled a cautious stance at its early May meeting, highlighting significant uncertainty around the duration and scale of current tariffs. This uncertainty included how long the tariffs remain in place, the rates at which they will be set, and the potential impacts on both inflation and employment.

The FOMC concluded that with unemployment low and the economy performing solidly, it could wait for further clarity from the data and on the ultimate rate of tariff imposition (the latter a good thing given the very large temporary reduction in US-China tariffs that was recently announced). US monetary policy was also seen as “well-placed”. This means the Fed can maintain current slightly restrictive interest rate settings, while it waits for any temporary price rises to pass, before reducing interest rates later this year to counter any contractionary impact on the economy.

 

Australian Q1 CPI Clears Path for May Interest Rate Cut

The RBA left interest rates unchanged in April. The Board expressed concern over the extent of further interest rate cuts priced by markets and sought clearer signs of sustained progress in reducing inflation. Notably, the April 1 meeting took place just one day before the announcement of higher than expected US tariffs added fresh uncertainty to the global economic outlook.

When the RBA meets on May 19-20, it will have a more complete picture of the economy, including:

• Q1 CPI Data: Core inflation is continuing to moderate toward the 2.5% midpoint of the RBA’s target range, indicating ongoing progress in reducing price pressures.
• Labour Market Conditions: The unemployment rate remains very low, remaining at 4.1% in April, providing an important underpinning for consumer spending.
• Global Trade Outlook: Early trade negotiations suggest a more modest contractionary impact from tariffs than initially feared, reducing the immediate downside risks to the Australian economy.

Given this context, a further 25 basis point cut to the cash rate, bringing it to 3.85%, appears likely. Additional cuts may follow before the end of 2025 if the labour market softens more than the RBA’s current forecasts.

 

What it means for my business…

With US trade policy likely settling at “manageably” higher tariffs (10% for most countries), the global economic impact may be less severe than initially feared. Manageably is used here to describe a situation where US and global growth slows, unemployment rises and there is a one-off shift higher in prices in the US, but not a very significant economic shock.

For Australian businesses this likely means:

• Modestly slower growth and gradual easing of Australia’s tight labour market as global demand moderates.
• Opportunities and potential advantages in finding new export markets, particularly in China, securing lower shipping costs, and sourcing highly tariffed goods from countries like China at more competitive rates.
• Modest further interest rate reductions in Australia, including a 25 basis point reduction in May, with the potential for further easing before the end of the year.

 

 

Author: Ivan Colhoun  Consulting Economist for Bank of Sydney Bachelor of Economics (Hons) Ivan is a highly experienced chief economist and keynote speaker on the Australian economy and financial markets. His career has included leadership roles within financial and professional service organisations, as well as the Reserve Bank of Australia.