Will Australia go into a recession? – Forbes Advisor Australia

There are many recession warnings around the world. Just last week, the World Bank warned of “devastating” consequences “as more countries slide into recession,” and transport company FedEx lowered its growth forecasts, with the CEO saying he sees the start of a global recession.

In the US, the central bank has indicated that it will prioritize fighting inflation over sustaining growth. This suggests that the US Federal Reserve will hike official interest rates high enough to trigger a recession if it needs to bring inflation down from current record highs.

The US bond market is flashing one of the clearest warning signs of a recession. Yields on two-year bonds are higher than 10-year bond yields if they were lower in normal times. This suggests that the market believes that the longer-term perspective is safer than the short-term and implies that the short-term will include a recession. The phenomenon is known as the “inverted yield curve”.

China is pursuing a zero-Covid strategy that has choked its economy while trying to recover from damaging financial excesses by its property developers.

In this increasingly integrated global economy, is there a way Australia can avoid a recession? Prior to 2020, Australia went 30 years without a recession. Could we really have two in three years?

Looking at consumer confidence data from ANZ Roy Morgan, it’s hard to conclude otherwise. People’s confidence in the economy is low this time next year. We are bleak about the prospects – as bleak as it was in 2020, before vaccines had been developed and the shock of the virus was still new

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The gloom is warranted from one perspective: the RBA is working very hard to cool economic growth. It hiked interest rates extremely quickly, from 0.1% to 2.35% in three months. They are expected to lift more.

Rate hikes work in several ways to slow the economy and fight inflation:

  • Households pay more for their mortgage and leave less for discretionary spending.
  • The Australian dollar is appreciating, making imports cheaper and discouraging people from shopping locally.
  • The profitability of saving is higher, which encourages people to save rather than spend.
  • The cost of borrowing is high, making companies less likely to borrow and spend.

How does a slower economy reduce inflation? The rate hikes are designed to divert money from spending by local businesses and make those businesses feel like they can’t raise prices and wages. The RBA’s job is to keep inflation between 2% and 3% on average each year, and right now inflation is well above that target, as the next chart shows.

Unlike the US, Australia’s yield curve is not inverted. It’s a sign that the bond market is confident that the RBA won’t push things too hard and inadvertently crush the economy.

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But the World Bank is less confident that central banks know what they are doing. When a central bank tightens monetary policy, it usually responds to local conditions and acts more or less alone. But this time there is “synchronicity,” the World Bank warns. Every central bank is doing the same thing at the same time, as the next chart shows, and that could mean that each player has to do less than they think.

Here’s the World Bank’s acting vice president for Equitable Growth, Finance and Institutions, Ayhan Kose: “Recent monetary and fiscal tightening … could reinforce each other by tightening financial conditions and amplifying the global growth slowdown.”

The market expects that the RBA could overshoot its target and reverse rate hikes. It projects a 50% chance of a rate cut in 2023. The Commonwealth Bank has a bolder prognosis: two rate cuts (25 basis points each) in late 2023, as the RBA realizes its job is well and truly done.

observing the data

The RBA has said it will monitor the data to see how many more rate hikes are needed to cool inflation without wrecking the economy. The problem is that most of the data is for periods a few months ago, before rate hikes got much traction. Rates will take a while to take effect – around 18 months, according to monetary policy researchers. This means that the full effect of actions already taken cannot be known before making decisions about the next action to be taken. That’s why the RBA boss describes his job as “clouded by uncertainty”.

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In such a situation, “leading indicators” become: very useful. Of course, statisticians can only tell us about the past, but at least they can measure how people planned for the future back then.

Job advertisements are an example of a leading indicator. From the strength of job advertisements, we can find clues about the future strength of the labor market. What we see in job ads is that while the hiring rate is still strong, it’s not getting any stronger. Meanwhile, the OECD’s composite leading indicator is falling.

Such indicators suggest that the likelihood of a recession in Australia is now higher than it was before inflation forced the RBA to act. But would it be so bad?

One hope is that a recession is merely a “technical recession.”

The standard definition of a recession is two consecutive three-month periods of contracting output – ie two consecutive quarters of negative growth.

But that doesn’t always mean severe pain. If unemployment doesn’t rise and we recover quickly thereafter, Australia could return to the sweet spot: low unemployment, strong growth and inflation under control.

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