Tariffs: what next?

The suspension of extreme tariffs between the US and China for 90 days, and the immediate reduction in interim additional tariff levels on imports is good news.

“And ANZ Research expects that weaker US demand, profit margin compression on the US content of import prices and lower exporter prices will limit the impact of tariffs on the price level.”

It helps to avert the worst-case outcomes for growth and inflation.

The announcement from Geneva on May 13 revealed an agreement that US tariffs on Chinese goods would reduce to 30 per cent while Chinese tariffs on US goods would fall to 10 per cent, a 115 percent point fall by both sides.

Nevertheless, it is evident that US tariffs will be higher than they were before the announcements on 2 April Liberation Day.

Following the US’ talks with China and the UK, and given that most US imports from Canada and Mexico are excluded from the new tariff regime, our early estimate is that the future average baseline US tariff will be around 10 per cent. This is assuming China makes progress on clamping down on fentanyl exports.

Carve outs

There will be sector specific tariffs that could be higher as the US strengthens economic security in critical sectors.

Although quotas and purchasing agreements may help to reduce the aggregate level of those tariffs.

There will also be carve outs for certain products.

ANZ Research’s published forecast profile for the US in 2025 assumed that the US tariffs were unlikely to be implemented at the levels announced on Liberation Day and would be dialled back.

The subsequent suspension of reciprocal tariffs for 90 days, recent bilateral talks and expectations that more trade deals will be announced in coming weeks reinforce this view.

The evolution of tariff announcements has been broadly in line with our assumptions.

Therefore, ANZ Research is not changing its average growth (1.5 per cent) and inflation (3  per cent) forecasts for 2025, but it has cut the probability of recession in 2025 to 30 per cent versus 40 per cent.

Impact on prices

Regarding prices, research from the Boston Fed estimates that 11 per cent of the headline Personal Consumption Expenditures price deflator (PCE) – which tracks changes in domestic personal consumption prices - and 10 per cent of the core measure, comes from imports.

A 10 per cent increase in tariffs could therefore drive-up core PCE by 1 per cent.

However, most imports from Mexico and Canada, which account for 30 per cent of US imports, are excluded.

And ANZ Research expects that weaker US demand, profit margin compression on the US content of import prices and lower exporter prices will limit the impact of tariffs on the price level.

ANZ Research estimates that the impact on the PCE may be in the region of 0.4 per cent.

President Trump has also announced a reduction in the cost for many prescription drugs.  Prescription drugs had a 2.7 per cent weight in the Q1 PCE deflator. Trump’s announcement could reduce the PCE by 0.05-0.1 per cent.

Inflation estimates and fed funds

Based on available information, ANZ Research estimates that the core PCE deflator will be 0.3-0.4 per cent higher at the end of 2025, relative to pre-Liberation Day estimates.

The suspension of reciprocal tariffs for 90 days, suspension of extreme tariffs on China and willingness of the US to engage in trade negotiations with counterparties reduces the risk of inflation persistence.

An absence of inflation persistence reinforces our expectation that the Federal Open Market Committee (FOMC) will resume cutting interest rates later this year.

ANZ Research still expects the FOMC to be patient, analysing the incoming data before adjusting monetary policy.

ANZ Research continues to expect it will be in the third quarter, and probably September, before the FOMC cuts rates.

ANZ Research forecasts two rate cuts of 25 basis points each in 2025.

The current strength of the labour market is affording the Fed time to observe how tariff and trade policy will affect the broader economy.

The current 3 month average of nonfarm payroll employment is 155,000, up from 133,000 in March.

 The 4.2 per cent unemployment rate is close to historic lows and high frequency labour market indicators like initial claims are not flagging an unfolding recession.

First quarter Gross Domestic Product also highlighted that private sector activity has remained healthy.

Headline GDP contracted 0.3 per cent on a seasonally adjusted annual rate (saar) owing to a significant drag from the front loading of imports.

However, real personal consumption expenditures rose 1.8 per cent saar, similar to the first quarter of 2024 despite the headwinds from the LA wildfires and severe weather in January this year.

Welcome news

The de-escalation in trade tension between the US and China is welcome news.

ANZ Research expects the Fed will continue to be patient with respect to future rate cuts, needing to see incoming inflation data before adjusting monetary policy.

ANZ Research judges that the de-escalation in trade tension reduces the risk of inflation persistence as it theoretically supports a fall back in inflation expectations and reduced risk of disruption to supply chains.

Nevertheless, ANZ Research maintains a view that the US economy will slow this year given a higher tariff burden and greater uncertainty.

ANZ Research forecasts GDP will rise an average of 1.5 per cent.

Owing to slower demand and some profit margin compression, ANZ Research expects the impact of tariffs will be one-off.

ANZ Research expects the FOMC will resume rate cuts in September and anticipate two 25 basis point cuts in the fed funds target, leaving the target range at 3.75-4.0 per cent by year-end.

Brian Martin is Head of G3 Economics, ANZ, and Bansi Madhavani is an Economist, ANZ.

This is a version of work originally published on ANZ Research on May 13, 2025 (“De-escalating US-China tensions support FOMC rate cuts from Q3”). Subscribers can access the research here.