Is Australia headed for a recession?

Is Australia headed for recession?

On Wednesday, the Deputy Governor of the Reserve Bank of Australia warned that the outlook for the global economy was not good.

“It’s a bit on the edge,” she said.

Less than 48 hours later, the Bank of England said Britain was likely already in recession.

There is growing concern about the United States, which appears to be headed for recession.

And China’s economy is strained under pressure from its zero-COVID policy and problems in its gargantuan real estate market.

Will a recession in Australia be inevitable?

A “likely” recession

RBA officials say at this stage they still have faith in Australia box avoid a recession.

They say our exceptionally tight labor market and the level of savings in the economy can hopefully insulate Australia from any negative shocks from abroad.

But not everyone is optimistic.

Some economists suspect that because so many countries are raising interest rates in an uncoordinated frenzy, global growth will slow significantly over the next 12 months and Australia will not be able to avoid the fallout.

Jo Masters, Barrenjoey’s chief economist, said a likely recession was “on the cards” for Australia.

Why? Partly because the RBA will be forced to continue raising interest rates as long as other countries continue to do so, and this will push the Australian economy into recessionary territory.

The RBA’s cash rate target is currently 2.35%.

Ms Masters said her modeling suggested a cash rate of around 3% would be enough to bring inflation back into the RBA’s target range by early 2024, but the RBA is likely to raise the rate eventually. cash at 3.35%.

“It will have economic consequences – weakening growth prospects and seeing the unemployment rate rise,” she said.

“B*Eco modeling suggests this would drive the economy into recession.”

And what will happen once Australia is in recession?

Jo Masters, Barrenjoey's Chief Economist
Barrenjoey’s chief economist, Jo Masters, expects house prices to fall by 15%.(ABC News: Jo Masters )

Ms Masters said that when domestic economic activity begins to weaken rapidly next year, the RBA will eventually cut rates again to stimulate activity.

And those rate cuts will happen towards the end of next year.

So the RBA will raise rates more than it would like in the coming months – pushing the economy into recession – and then it will start cutting rates to make the recession as painless as possible.

“That should be enough to leave any recession relatively short and shallow, and that may be what is needed to cement the path back to 2-3% inflation,” Ms. Masters said.

She believes the RBA will raise the cash rate target by 0.5 percentage points next month, from 2.35% to 2.85%.

Is the cash rate heading towards 3.6%?

Bill Evans, Westpac’s chief economist, made a similar point.

In July, he already predicted that the RBA would raise the cash rate target to 3.35%, but this week he raised that forecast.

He said the stubborn outlook for high inflation and wage growth in the United States, as well as rising interest rates around the world, had changed his mind.

He said he too suspected the RBA would raise the cash rate by another 0.5 percentage points next month.

But he now believes the RBA will eventually raise the cash rate target to 3.6% early next year.

He said that since global central banks planned to continue raising rates, the RBA should follow suit to prevent the Australian dollar from losing too much value.

Why? For reasons similar to Mrs. Masters.

If foreign currencies were allowed to gain too much value against the Australian dollar, it could encourage foreigners to buy more Australian goods and services than they otherwise would have, and it would make it more difficult for the RBA to eliminating inflation from the Australian economy.

Mr Evans said this was a key reason why the RBA would not want Australia’s cash rate to lag too far behind the key US interest rate.

“Recall that the main reason the RBA reluctantly embraced quantitative easing in 2020 was to keep the Australian dollar competitive,” he said.

“The RBA Governor would be concerned that such a widening of the expected yield differential with global rates will have implications for a weaker Australian dollar complicating the inflation challenge.”

At this point, he thinks Australia’s economy will only grow 1% in 2023.

Overall, he thinks central banks are adopting a “least regret” policy by prioritizing inflation control “at the potential cost of short-term growth.”

Rolling back the politics of decades

BetaShares chief economist David Bassanese also thinks the RBA is likely to raise the cash rate target by 0.5 percentage points next month.

He said the RBA would not want the Australian dollar to lose too much value against other currencies.

“At 66 cents US, the Australian dollar has already fallen 13% from its peak of 76 cents US in April this year,” he said.

“I expect the Aussie dollar to end the year at around US62-63c.”

So, is there a clear coordination problem between global central banks?

As central banks around the world raise rates to kill inflation, this creates pressure on those same central banks to keep raising rates to prevent their currencies from losing value against other major currencies.

Meanwhile, the speed and magnitude of global rate hikes are pushing the world’s major economies into recession.

Earlier this week, RBA Deputy Governor Michele Bullock was asked if there was any case for some coordination among global central banks to halt the damage from rising US interest rates. and the strengthening of the US dollar.

But Ms Bullock pushed back on the idea, saying it would set the policy back decades.

“Exchange rates can play a very positive role,” she said.

“In Australia, we’ve generally thought of it that way because it gives us the flexibility and ability to manage our own policies, to a large extent, without necessarily having to follow what others are doing in other countries.

“We’re not entirely immune, but it gives us more flexibility.”

She said she didn’t think global central bank coordination was the right thing to do in this situation, despite everything.

“In a sense, the US dollar reacts to relative economic conditions, as well as inflation and interest rates in the United States, relative to other countries,” she said.

“That’s what you would expect.”

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