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Why a recession in Australia is very unlikely

·4-min read
Composite image of Australian money, and pedestrians on a busy street, amid recession fears.
Talk of recession seems misguided at best. (Source: Getty)

The chance of a recession in Australia in the next year is remote despite what some of the more excitable commentators and economists are claiming.

The start of the interest-rate-hiking cycle, the moderate fall in house prices and signs of slower economic growth more broadly are cited as reasons why the economy is poised to nose-dive into recession.

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While it can never be ruled out, a recession in Australia is very unlikely for a few simple reasons.

Most important is the outlook for business investment.

While some consumers are hunkering down under the weight of cost-of-living pressures and rising interest rates, the business sector is running at full capacity.

As a result, it is ramping up capital expenditure plans for machinery and equipment, IT and buildings and structures.

Part of this is a response to a period of under investment during the COVID lockdowns – many projects that were shelved in 2020 and 2021 are now back in full swing.

The recent NAB survey of business conditions showed the most extreme measure of capacity utilisation on record.

While part of this is a result of a shortage of workers – which is a further sign of economic strength by the way – it means investment is poised to boom.

According to the Reserve Bank (RBA), business investment is forecast to rise 4.9 per cent through 2022 with further growth of a hefty 6.6 per cent through 2023.

These forecasts appear too low but, in any event, suggest an important floor under growth elsewhere in the economy for the next two years.

At the same time, massive international trade surpluses are being locked in. A combination of strong commodity prices and solid export volumes are feeding into monthly trade surpluses around $15 billion.

This is providing a huge income boost. Even with commodity prices looking set to edge lower, and the global economy slowing as world central banks tighten monetary policy, the trade outlook remains favourable.

The pending increase in immigration will also be supportive of the economy. An annual target for immigration of close to 200,000 people will fuel demand in the economy through housing, jobs and spending.

It is also clear that the labour market has never been stronger. The unemployment rate is at a 48-year low and the number of job vacancies is higher than there are people unemployed – an incredible sign of economic strength.

And while the labour market does lag the broader business cycle, the current demand for labour, the acceleration in wages growth and increase in hours worked will boost household incomes and act as at least a partial offset to cost-of-living issues and the effect of interest rate hikes.

Slower economic growth does not equal a recession

It must also be emphasised that the economy is slowing. That is beyond debate and it is desirable that it does slow from the boom that was witnessed as the economy adjusted from the COVID lockdowns.

Indeed, the RBA with its interest rate hikes is aiming to see the economy slow – it is the only way to get inflation lower and back to the target band.

Annual GDP growth above 3 per cent with the unemployment rate below 4 per cent will never see the inflation target met, which is why the RBA is forecasting GDP growth to slow to around 2 per cent in the next 12-24 months and the unemployment rate to edge back up to 4 per cent as it continues to hike interest rates.

These are essential economic outcomes for the 2-3 per cent inflation target being met.

Uneven road ahead

As is always the case in economics, the slowing economy will not be even – some sectors will be stronger, others weaker.

The highest-profile examples of these issues will see the household sector weakening while the business sector will be resilient.

The end game is that by the middle to end of 2023, economic growth will be lower than it is today, the unemployment rate a fraction higher and, as a result, inflation lower.

The current drivers of the economy suggest this outlook is squarely on track.

Talk of recession remains horribly misguided, not least because of a strong business sector, booming export earnings, a return to immigration and moderate but decent growth in household spending.

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