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A week can be a long time in financial markets, and this is especially so since US President Trump returned to office on 20 January. Over the weekend, President Trump imposed 25% tariffs on Canada and Mexico and 10% additional tariffs on China, unsettling markets. But before the tariffs had even begun, a one-month reprieve to the start date was agreed with Canada and Mexico in return for promises to strengthen borders; this short-term truce will likely allow negotiations to continue.
In contrast to the Canada and Mexico reprieve, tariffs on $US439b of US imports from China were implemented from 4th February. China promptly announced a number of retaliatory measures, to take effect from 10th February. The retaliatory tariffs were much smaller in magnitude than the US tariffs imposed on China, applying to around $US20b of goods, and were more targeted. The package of retaliatory measures included tariffs on US coal, oil and gas, export restrictions on 25 critical minerals to the US, and the addition of several US companies to an “unreliable entity” list.
Markets have settled over the course of the week, consistent with our assessment that these developments on tariffs are unfolding broadly in line with our expectations for a scaled down version of Trump’s touted policies. We have written at length about the impact of a Trump presidency on the US (A conga line of events to hit markets) and global economies (President Trump takes office). This week, we turn our attention to the implications for Australia.
Being a small open economy, Australia is not immune from the downside risks to growth and upside risks to inflation associated with Trump’s policies. However, Australia’s direct trade linkages with the US are quite small, and this helps limit the fallout to Australia’s economy. Exports to the US are around only 5% of Australia's goods exports. In 2023, Australia exported around $22b of goods to the US, which included almost $3b of beef, $1.5b of pharmaceutical products and around $1b each of gold coins, medical instruments and parts for aircraft/spacecraft.
Australia is also a small market from the US perspective, representing only 0.5% of total US imports. The import shares are many times larger for the countries in focus for the first round of Trump’s tariff negotiations, at 13.6% for Canada, 15.4% for Mexico and 13.9% for China. In addition, the US runs a trade surplus with Australia, unlike the trade deficits it has with Canada, Mexico and China; this makes Australia less likely to be a target for US trade policy. The US goods trade surplus with Australia was $US18b in 2024.
More significant than the direct trade impact of US tariffs is the indirect impact on Australia via trade linkages with China, who is Australia’s largest trading partner taking around one-third of our exports. How China responds to the imposition of US tariffs has a critical impact on how Australia’s economy fares. In our baseline forecast, Trump increases tariffs on China by almost 15 percentage points (slightly more than the 10% currently announced), but only applies small and targeted tariffs on imports from other countries and China’s economy softens but does not collapse. Growth in the Australian economy will be 0.1-0.2% p.a. weaker over the next two years due to the tariffs, but this is not enough to derail the recovery in household spending that is currently underway.
However, in a scenario where Trump implements his full policies including 60% tariffs on China, and China responds with tit-for-tat tariffs, sparking a global trade war, the impact on Australia will be significant. We estimate that Australian GDP growth will be cut by around 0.5-0.6% per annum over the next two years, which is enough to inhibit the recovery in Australia’s economy. If, instead, China responds with small, targeted tariffs, and fiscal stimulus to support its domestic economy, Australia could be a net beneficiary. To date, China’s retaliatory response to US tariffs, in the form of targeted tariffs on US coal, oil and gas, as well as export controls on critical minerals, are areas where Australia could reap significant benefits.
While the physical trade flows could take some time to play out, a more immediate impact of Trump’s policies is via asset prices that respond to expectations of future outcomes. The inflationary impact of tariffs has already driven up global interest rates and weakened the Australian dollar, consistent with our simulation results. A more competitive Australian dollar cushions the impact of a global downturn but can exacerbate any inflationary impacts of higher tariffs.
We believe domestic-specific factors, such as the recovery in household disposable incomes and easing domestic cost pressures, will have a more dominant impact on Australia’s economy and the RBA’s policy decisions than Trump’s tariff policies. However, the Australian dollar is susceptible to further falls in the face of Trump’s “shoot first, negotiate later” modus operandi, which could make the RBA’s job of balancing domestic needs with international risks even more difficult.
