The Reserve Bank of Australia says heightened geopolitical tensions and policy uncertainty in major economies have the potential to interact with existing vulnerabilities, and has identified three key vulnerabilities that could be exposed.
…yes, that’s a round-about way of saying the Trump administration’s tariff policies could spell doom and gloom for Australian households and businesses, according to the RBA’s April Financial Stability Review.
So, what exactly are these existing vulnerabilities and how are tariff measures affecting them?
The RBA says ongoing uncertainty about U.S. international trade policies, and the reactions that this may trigger, could chill business investment and household spending decisions, and pose substantial headwinds to global economic activity and inflation.
Find out more: Reciprocal tariffs: Breaking down the percentages
There’s also considerable uncertainty about the effects of possible fiscal, regulatory and other government policy changes on global growth and inflation.
All these uncertainties add to existing cyber incidents and climate change risks.
Three pressure points
Three key vulnerabilities, the RBA says, stand out as having the potential to significantly affect financial stability in Australia.
Key international financial markets amplify by long-standing vulnerabilities in the global NBFI (non-bank lenders) sector. Compressed risk premia and a concentration of exposures in equity markets increase the likelihood that adverse news - triggered by any number of global risks in a highly uncertain environment - will spark a disorderly correction in international asset prices.
Rising leverage and the risk of liquidity mismatches among some NBFIs have the potential to amplify such a shock.
Imbalances in China’s financial sector. Chinese policymakers appear to have adopted a more supportive counter-cyclical policy stance of late, but despite easing economic conditions, these policies could exacerbate long-term debt vulnerabilities in the Chinese financial system.
The U.S. tariffs on Chinese imports may necessitate a further policy response from Chinese authorities to support economic activity.
If macro-financial risks materialise in China, the stress could spill over into the global financial system, including Australia, via trade channels and increase risk aversion in global financial markets.
Operational vulnerabilities result from growing complexity and interconnectedness. While digitalisation offers the potential for substantial efficiency gains in the financial system, it can also increase the complexity and interdependence of the supporting systems.
As a result, operational systems in key financial market infrastructure and key institutions are increasingly vulnerable to technology outages and malicious cyber-attacks.
The threat landscape for operational risk could also worsen further in the context of escalating geopolitical tensions.
Squeeze on the financial system
The RBA says if risks materialise, those aforementioned vulnerabilities could cause spillover effects on the Australian financial system:
Via a significant increase in risk aversion in global financial markets
This could sharply increase financing costs and restrict Australian firms’ and financial institutions’ access to funding and liquidity on global markets.
It could also create liquidity strains for Australian banks and NBFIs, such as superannuation funds, and intensify financial pressures on borrowers and even finance balance sheets - as well as limit credit availability in the Australian economy.
Via the impact on the real economy outlook
A global economic downturn, particularly one that leads to a sharp slowdown in China (Australia’s most significant trading partner), could negatively affect the nation through trade channels – including commodity prices and investment – and spill over into weaker spending by Australian consumers and businesses.
Via severe operational disruption
A direct and rapid impact could arise from disruptions to the financial system and national infrastructure, or to a key financial institution, and could also undermine public confidence.
The Reserve Bank is cautious
RBC Capital Markets says the RBA will remain reactive and its assumption that China will step up with stimulus and lend support is sound, but the effectiveness of such policy measures is more uncertain.
“A sustained lift in household consumption demands more fundamental reforms, the overcapacity in construction needs to be reduced and the opaqueness of government debt remains,” RBC Capital Markets chief economist Su-Lin Ong said.
“While this week’s steady rate decision and cautious tone suggests a more drawn out modest easing cycle than our base case for two more cuts in May and August, today’s global developments perhaps argue the opposite and also suggest downside to this view.”
