If the global outlook worsens sharply from the trade war, a swift policy response including fiscal stimulus measures would seem appropriate. Furthermore, if conditions worsen, moves from the Reserve Bank of Australia could play an important role. With the official cash rate already closing on its lower boundaries, quantitative easing looms as a legitimate response.
Even with stimulus, a slowing domestic economy would make it hard for business sentiment to remain optimistic and would depress growth further as investment and hiring fell away.
Over & above
Although there is spare capacity in Australia’s labour market, it is the global backdrop which could hasten the RBA toward significant policy easing - even over and above what the market is already pricing in.
The potential costs to the global economy and Australia will rise as more countries are impacted by the trade dispute. China is vulnerable from the direct impacts of tariffs as well as from deteriorating sentiment around business investment.
China has seen an almost continuous decline in trade as a share of GDP since 2007. Despite that decline, China still has significant exposure to the US, which receives more than 22 per cent of its exports.
US tariffs on China are likely to damage growth. ANZ Research estimates the direct effects of the trade war will shave 0.5 per cent off China’s GDP.
Globally, this means businesses will hold off on investment which in turn will slow other components like consumption and employment. ANZ Research expects the US-China dispute will continue into 2020 and that China’s economic growth will come under pressure.
The first impact on Australia’s GDP would come from a decline in national income as exports and foreign investment slow.
During a negative global shock, Australia’s terms of trade typically deteriorates through falling commodity prices. Natural resources make up the largest share of Australia’s exports so commodity prices are a key factor in determining the terms of trade - and by extension, the size of the impact on national income.