The risk of a downturn remains high, according to AMP’s chief economist Shane Oliver, who believes there is now a 45 per cent chance of a recession in Australia.
Dr Oliver, who projected significantly lower odds of a recession earlier this year, warned the Reserve Bank of Australia (RBA) could escalate the risk of a recession if it continues to deliver monetary policy tightening.
“The more the Reserve Bank continues to raise interest rates, the greater the risk that they will end up overdoing it and bringing on a recession,” he told InvestorDaily on Thursday.
After handing down 11 interest rate hikes since May last year, including a surprise 25 basis point hike earlier this month, Dr Oliver predicted the RBA would hold at its next meeting in June. But he maintained the likelihood of further hikes is very high.
The ongoing monetary tightening of central banks in response to inflation, Dr Oliver said, has been the main driver behind the recent recession risk.
While talks of a recession have persisted since early last year, he noted economic data has so far been relatively resilient, albeit soft.
“To some degree, the recession forecasts keep getting pushed out or revised up because, even though the economic data has been weak, it hasn’t shown a collapse,” he said.
“At the same time globally, we’ve seen the recovery in China provide a bit of an offset to the softness in Europe and the US. But the risk is still there.
“Most economic indicators you look at, such as yield curves which are well and truly inverted, collapsing money supply, falling leading economic indicators in the US, they’re all warning of a high risk of recession, particularly in the US at this point in time.”
Moreover, Dr Oliver assessed that the Chinese growth story appears less robust than first thought, with a stronger emphasis on services rather than manufacturing. This has been reflected in the relatively weak performance of commodity prices such as copper and the weakening Australian dollar.
Current circumstances have been further complicated, he said, by the substantial surplus savings individuals have amassed since the pandemic.
“There’s the danger that, sooner or later, those excess savings will run out. People will have done their revenge spending and their revenge travel, and then suddenly, we’ll have a Wile E. Coyote moment, as the coyote goes off the cliff and then looks down,” Dr Oliver said.
Dr Oliver said a similar situation was seen in the late 1980s and early 1990s, when the economy remained resilient amid ongoing rate hikes before suddenly dipping into recession.
“The problem is, it can often take a while before it arrives because of the long lags from monetary tightening to slower spending. It takes a while for rate hikes to be passed on to customers, it takes a while for customers to adjust their spending,” he explained.
“But this time it’s been partly offset by people without mortgages having lots of savings buffers and continuing to spend. But at some point, something gives, and then you end up with a much weaker growth story and possibly recession.”
Speaking at the Morningstar Investment Conference in Sydney, Mr Delaney said central banks couldn’t afford to let inflation get out of the bag.
“Who wants to be the central banker who brought back inflation? I just think it’s clearly the case [that] people will forgive them for having a recession, but they won’t forgive them for ongoing inflation. History will write them off,” he said.
“So I think they’re going to keep on leaning into that, which also increases the probability of getting a recession, because they’re going to lead into inflation pretty hard, and they’ll be successful at it.”
Talking ourselves into a recession
Dr Oliver noted there is also the possibility all the recent talk of a recession may instigate a detrimental cycle, where businesses and consumers reduce their spending, thereby exacerbating the onset of a recession.
“The problem with that is, it’s always hard to know to what degree a recession is partly because of psychology, or animal spirits, turning more negative – in other words, people talking about it and therefore getting it – and to what degree it’s driven by fundamental factors,” he said.
According to AMP’s chief economist, the reality is that households have experienced a significant hit to their cost of living, with higher interest rates and lower real purchasing power, which Dr Oliver pointed out has historically had the effect of “slowing things down”.
“Indeed, central banks want to slow things down and the history has been, when they wanted to, that they often go too far and you end up with a recession,” he continued.
“Australia missed out on major recessions over the 30 years prior to the pandemic, but in the US prior to all of the recessions, the early 80s, the early 90s, the tech wreck, the GFC, there was always a monetary tightening before it, which led to a recession.
“Psychology can accentuate the problem and make the recession worse, or make the downturn worse and can have the effect of tipping over a downturn into a recession, but it’s always hard to disentangle the psychological impact and the fundamental reality of monetary tightening,” Dr Oliver concluded.
