RBA Cuts Interest Rate 25 Basis Points Amid Inflation Ease, Trade War Fears

The Reserve Bank of Australia (RBA) has lowered its policy interest rate by 25 basis points, bringing it down to 3.85%, the lowest level in two years. This move comes as inflation concerns in Australia continue to ease, with the latest overall inflation data reaching a four-year low of 2.4% in the first quarter of 2025. The RBA anticipates that inflation will further decrease to around 2% by the end of 2026, below its baseline forecast of 2.6%.

Economic growth is also expected to slow down, with Australia's GDP projected to be more than 3% lower by the mid-2027 compared to the baseline scenario, which predicts GDP growth to rebound in 2025 and 2026. The RBA acknowledges that the global economic outlook remains uncertain, with increased volatility in financial markets over the past three months. While recent statements about tariffs have led to a rebound in market prices, there is still significant uncertainty surrounding the final scope of tariffs and the policy responses of other countries.

Geopolitical uncertainties are also prominent, with developments expected to negatively impact global economic activity, particularly if households and businesses delay spending until the outlook becomes clearer. This has contributed to a weakening of Australia's economic growth, employment, and inflation prospects. The RBA recognizes that the recent 90-day trade truce between the two largest global economies, the United States and China, has mitigated some downside risks to global growth. However, the RBA cautions that the current situation could still deteriorate into a more widespread and protracted trade war, posing significant downside risks to domestic GDP growth and leading to higher unemployment.

In a trade war scenario, if the U.S. reimposes higher tariffs under the "Section 301" trade act by 2026 and all countries retaliate, the RBA warns that Australia's unemployment rate could rise to nearly 6%. This downside scenario assumes a cumulative 85 basis points reduction in interest rates by the mid-2027, aligning with current market pricing. The RBA expects the Australian trade-weighted index to depreciate by 6% due to the trade war, providing some support for economic activity. Higher tariffs are generally seen as having an anti-inflationary effect on Australia, although a prolonged trade war could exacerbate inflationary pressures.

In an extended trade war, a larger portion of global trade would be affected by tariffs, making it difficult for most businesses to avoid the impact of higher tariffs on their production processes. Elevated tariffs could reduce productivity growth in affected economies through misallocation of resources, decreased business investment, and diminished innovation incentives. The RBA's actions reflect a broader trend among central banks worldwide, which are increasingly adopting accommodative monetary policies to shield their economies from the fallout of the trade war. By lowering interest rates, the RBA aims to stimulate economic growth, encourage borrowing and spending, and provide a buffer against the potential economic shocks that could arise from heightened trade tensions.