Will Australia Go Into Recession In 2024?

What is especially important when looking at the most recent inflation data is to understand that both services and non-tradeable inflation fell. The fall in prices is not just a result of Chinese trinkets we imported for Christmas but represents a real cooling at the beating heart of the Aussie economy.

This is exactly what the RBA is seeking by hiking rates from .1% to 4.35%. Rising mortgage repayments leaves a lot less for groceries, home repairs, petrol, going out for dinner, etc. And that’s the point. The RBA is raising the cash rate to pull money out of circulation—if people aren’t spending at the shops it is harder for business owners to raise prices. This is how they combat inflation, but when they do so, they risk sending the economy backwards.

To see where the recession risk is pressing hardest, you have to look at small and medium enterprises. They are the ones hurting the most.

Ben Thompson, co-founder and CEO of Employment Hero, is pessimistic about the economic outlook, based on weakening jobs growth.

“This overall downward trajectory indicates a small recession will likely occur later this year as SMEs pump the brakes on hiring and growth plans,” Thompson said.
But Australians seem unaware of any such risk. If we check my favourite indicator — Google Trends—we can see that last year’s concern has ebbed. The chart shows that as of January 2024, searches for recession are no higher than in any other year.

But here’s the thing. We are in a recession right now if you measure it in per capita terms. The Australian economy is growing overall, but it has grown 2.1% over the last year while the population has grown 2.4%. That means per capita (or per person) the economy has shrunk. Which is why so many of us feel cross and mad and ripped off.

The per capita recession began in 2023 and is ongoing. Commonwealth Bank thinks that the economy will continue to shrink until the second half of this year, in per capita terms.

Markets now think that the RBA will start cutting rates in the second half of 2024. The first rate cut is tipped to be in June.

Just how wobbly will the economy have to be for the RBA to start cutting?

Are we talking about a slight slowdown? Or a full-on catastrophe? Anything can happen from here, especially if global events have their way with us. The conflict in the Middle East could cause an especially pernicious kind of recession if it hurts the global economy and puts up petrol prices at the same time.

China’s troubles could also prove toxic for Australia’s economy. The Chinese authorities are finally letting the problematic firm at the centre of their property bubble go broke. It is called Evergrande and it has been circling the plughole for a very long time. Now it is finally going under. No doubt the Chinese government is letting that happen because they believe doing so won’t hurt the economy too badly. Might they be wrong?

The economic management of the Chinese bureaucracy over the last 30 years has been nothing short of spectacular. Scarcely a step has gone awry as their country leapt from abject poverty to global dominance. Which is why their first mistake will be so catastrophic, and we won’t be expecting it.

China’s economy is the second-largest in the world and it is Australia’s leading trade partner. They’ve always dodged recessions by pumping money into real estate and infrastructure when growth began to falter. But it is possible that the real estate sector has finally absorbed enough money (and enough Australian iron ore) and can take no more.

An important question for anyone with a stake in China’s success is whether any further stimulus in other sectors of the Chinese economy will be as effective in propping up growth. Their next area of focus seems to be agriculture and spending there could actually be tough on our economy if it means we export fewer agricultural commodities to China, or if global prices for food and fibre fall.

Reason for optimism comes principally from America. That country’s path out of inflation and back to healthy growth looks assured. Inflation is already at a near-normal level of 3.4% and that has been achieved without putting a lot of people out of work.

Forecasts for the American economy are for strong growth and modest inflation. Exactly where we want to be. If we can emulate the American trajectory we will be fine.

A recession is a period where the economy shrinks—there’s less income (or output, they should be the same at the national level) than in the past. They measure economic output every three months and if there’s two consecutive periods where output goes backwards, two consecutive quarters of negative economic growth, that’s called a recession.

The most recent national accounts show that Australia’s economy shrank on a per person basis in the most recent three-month period, but because of extraordinary population growth, the economy as a whole keeps expanding.

We worry about recessions because they often come with rising unemployment that takes a long time to stabilise. Large and long recessions are bad for people’s wellbeing: businesses fail, people lose their jobs, people lose their homes, mental health suffers and families break apart. We had a small recession during the pandemic, and the economy recovered very quickly from that, thanks to abundant government spending. At that time though, inflation was low so the government spending wasn’t counter-productive. In our current circumstance it could be.

The main risk to the Australian economy is that falling consumer spending causes a recession. Remember that the RBA is trying to engineer a dip in consumer spending. This is why the RBA governor keeps describing the country as being on “a narrow path”. Using their blunt tool of interest rate rises, the central bank is trying to fine-tune consumer spending so it falls enough to reduce inflation—but not too much.

As the next chart shows, spending remains elevated so far.

The economy is made up of spending by government, businesses and households. Household spending is the largest part. If it crashes, a recession becomes likely. The lack of spending then flows through to lower business income, and businesses stop hiring or even let people go. Unemployment rises, causing even more caution by households. It is quite a vicious cycle, and one that would traditionally be reversed by the RBA cutting rates rather than raising them. But if inflation is not yet under control, expecting rate cuts is unrealistic. We need to hope that seasonally adjusted fall in spending doesn’t carry through to January and the rest of 2024.

Locked-in inflation causes inflation expectations to rise, and increases the chance we step off the “narrow path”, requiring a recession to end inflation.

If people think inflation is temporary, they won’t worry too much about demanding high wage rises, and that helps stop inflation from getting locked in.

The RBA doesn’t need to hike rates as much, and the risk of recession is lower. But if people think high inflation is enduring or even permanent, the task for the RBA gets much bigger and the recession risk rises.

As the chart above shows. Inflation expectations from union officials are concerning. The RBA forecasts inflation next year of under 4% but officials expect inflation of over 4%. That could drive a wage price spiral and persistent inflation that requires the RBA to take more of a sledgehammer to the economy.

“If high inflation were to become entrenched in people’s expectations, it would be very costly to reduce later, involving even higher interest rates and a larger rise in unemployment,” said RBA Deputy Governor Michelle Bullock in a June 2023 speech.

“A deep and long-lasting recession would be likely.”

That’s quite the warning, and why inflation expectations are probably the key element to watch.