Powered by MOMENTUM MEDIA
investor daily logo

Stagflation threat more imminent than recession in Australia

 — 1 minute read

Economists are betting on a US recession next year, but in Australia, a stagflation is the more immediate threat.  

With inflation threatening to stifle the US economy, National Australia Bank (NAB) has joined a hoard of economists who are predicting a recession for the global superpower in 2023.

According to its latest US economic update, NAB believes a recession is likely next year on the back of restrictive monetary policy and other economic headwinds which could slow growth to a crawl by mid-2023.

Advertisement
Advertisement

Earlier this month, the US Federal Reserve lifted the federal funds rate by 75 basis points (bp), its largest since 1994, while signalling that more rate rises will be delivered in upcoming meetings.

NAB expects a peak fed funds rate target range of 3.25 per cent to 3.5 per cent in early 2023, a rate, it said, “reflects developments on the inflation front”.

While we see the weakest conditions for the US economy as most likely to occur in mid-to-late 2023, there is a risk that the trough in growth will come earlier than expected,” said NAB senior economist, Tony Kelly.

Earlier this week, the Commonwealth Bank (CBA) too weighed in on the US predicament, declaring that the US economy will enter a “mild recession in 2023”.

“Over 2022, we expect the US economy to expand by 1.3 per cent and by only 0.4 per cent in 2023.”

The idea, the bank’s economist explained, is that the Fed will need to tighten monetary policy into restrictive territory to ensure that inflation heads back towards its 2 per cent target, effectively stalling the economy.

A recession necessary to drive inflation down

Elsewhere, a major investment management corporation explained that while the Fed isn’t looking for a recession, “one would be needed if it wanted to drive inflation back down to 2 per cent”.

“The Fed seems dead set on raising rates this year to levels that, in our view, would clearly slow the economy,” BlackRock said in its latest weekly bulletin, noting that the central bank appears to be responding to the “politics” of current high inflation.

"But the Fed isn’t actually looking to slow the economy," the firm's economists said.

"Fed Chair Jerome Powell said the central bank is not trying to induce a recession. This reflects the Fed’s lack of acknowledgment of the policy trade-off."

In fact, according to BlackRock, the Fed is facing an acute trade-off - either slam down activity or live with persistent inflation while production capacity recovers.

"The Fed hasn’t acknowledged this. It assumes that a rapid return of supply capacity will help resolve high inflation – so any upside surprise to inflation will push it toward tighter policy, and a downside surprise on inflation won’t necessarily slow it down."

As such, even if the Fed were to jack up rates and then changes course, BlackRock noted that it still raises the risk of zero or negative growth and persistent inflation.

Local economy persevering

The immediate question facing local economists is whether a similar situation could possibly be replicated in Australia following an expected series of 50-bp interest rate hikes.

The central bank governor, himself, doesn’t think this is plausible.

Speaking at an event hosted by the American Chamber of Commerce in Australia (AmCham) on Tuesday, Philip Lowe said he does not see a recession on the horizon in Australia.

“If the last two years have taught us anything, we can’t rule anything out. But our fundamentals are strong and the position of the household sector is strong, and firms are wanting to hire people at record rates,” Dr Lowe said.

“That doesn’t feel like the precursor to recession. And interest rates, while they have gone up, are still low.”

But speaking to InvestorDaily on Wednesday, AMP’s Shane Oliver said that a recession in the US would certainly increase the risk for Australia because of its impact on confidence and demand for local exports.

“But it wouldn’t be inevitable,” the chief economist explained.

“For example, the US had recessions in 2001 with the tech wreck and 2008 but Australia avoided them with just a slowdown in growth".

But, he conceded, the scenario is slightly different this time around.

“The risk of recession here too would be higher given that the RBA is also aggressively raising interest rates”.

Stagflation more likely than recession

For Bell Assets, a stagflation is a lot more likely to grip Australia than a recession.

In its own market commentary, published on Wednesday, Bell Assets explained that the mixed economic picture could result in a further deceleration of GDP growth rates heightening the risk of stagflation.

Dr Oliver agreed.

“While the risk of recession in Australia is now high, the risk of a period of stagflation is higher,” he said.

“Whether there is a recession or not growth is still likely to slow sharply to subpar levels, involving little or no per capita growth, at a time when inflation is high”.

Earlier this month the World Bank significantly downgraded its forecasts for global growth in 2022 while warning of the rising risk of stagflation akin to that seen in the 1970s.

“Just over two years after COVID-19 caused the deepest global recession since World War II, the world economy is again in danger,” World Bank president David Malpass said at the time.

“This time it is facing high inflation and slow growth at the same time. Even if a global recession is averted, the pain of stagflation could persist for several years— unless major supply increases are set in motion.”

Parallels between now and the 1970s identified by the World Bank include supply shocks and elevated global inflation over the near term, prospects for weakening growth over the longer term, and the vulnerability of developing economies to the monetary policy tightening needed to rein in inflation.

Australia is currently looking at inflation highs of 7 per cent by the year’s end, alongside a cash rate above 2 per cent.

Market pundits, however, are pricing in a rate of 4 per cent in December, which, according to Dr Lowe, would require the sharpest tightening of monetary policy Australia has ever experienced.

Although appearing to dismiss the likelihood of a 4 per cent interest rate by the year’s end, Dr Lowe cautioned on Tuesday that “the market has been a better judge of where interest rates are going than we have over the past few years”.

As is commonly agreed, higher interest rates slow down the growth rate of the economy overall. And while the economy hangs in the balance, one thing is certain - the RBA is facing an increasing amount of pressure to make the right move. 

Stagflation threat more imminent than recession in Australia

Economists are betting on a US recession next year, but in Australia, a stagflation is the more immediate threat.  

investordaily image
investordaily image
ID logo
Maja Garaca Djurdjevic

Maja Garaca Djurdjevic

Maja's career in journalism spans well over a decade across finance, business and politics. Now an experienced editor and reporter across all elements of the financial services sector, prior to joining Momentum Media, Maja reported for several established news outlets in Southeast Europe, scrutinising key processes in post-conflict societies.

related articles

Website Notifications

Get notifications in real-time for staying up to date with content that matters to you.