As the RBA attempts to prevent the ship that is the Australian economy from sinking, central banks and economists alike are beginning to come to terms with the very real prospect of a recession.

Speaking to Congress to deliver the US Federal Reserve’s Semi-annual Monetary Policy Report, Chairman Jerome Powell floated the possibility of a recession.

“We think it will be appropriate to raise rates above a neutral level into a modestly restrictive level because this is very high inflation that is hurting everybody,” Mr Powell said.

“Of course, we are not trying to provoke a recession, but we think it is absolutely essential that we restore price stability.”

Mr Powell believes high inflation will become rooted into the US economy if there is a failure to restore price stability.

Currently, the United States has an annual inflation rate of 8.6% - its highest recorded figure since December 1981. Comparing this to Australia, our annualised rate of inflation sits at 5.1%.

It is however important to keep in mind, the Fed is ahead of the RBA, given the US calculates the rate of inflation monthly, compared to Australian data published quarterly by the ABS.

Groups such as CPA Australia have called on the ABS to change to a monthly inflation release.

There was no sugar-coating from CommBank Head of International Economics Joseph Capurso, noting the Fed does not have a good record of engineering a soft economic landing, with the US economy to enter recession in 2023.

Despite this track record, Westpac Chief Economist Bill Evans expects to continue to see a more aggressive approach to stall the US economy, further echoing the risk of a mild recession in the second half of 2023.

What's the go in New Zealand? 

New Zealand is experiencing first-hand higher consumer prices, excessive demand for labour yet a slowing growth rate of Gross Domestic Product (GDP) – the perfect storm for stagflation.

With the Reserve Bank of New Zealand confident the New Zealand economy can avoid a hard landing, BNZ is not so sure.  

BNZ Senior Market Strategist Jason Wong said central banks are between a rock and a hard place, needing to raise rates to bring inflation down, but against a backdrop of rising risk of recession.

“We think that recession risk for the NZ economy remains very high, against the backdrop of slower global growth, surging interest rates and a tumbling housing market,” Mr Wong said.

Further, BNZ head of research Stephen Toplis said the real hurt is instead to be expected this time next year.

“A technical recession will be late this year or early next year following a couple of quarters of negative growth,” Mr Toplis said.

What does this mean for Australia?

Economists back on home soil echo sentiment felt in New Zealand, with central banks tipped to front load interest rate rises for the remainder of the year before the chance of rate cuts in the second half of 2023.

AMP Senior Economist Diana Mousina said the risk of an economic downturn has increased in the next 12-18 months.

“In our view, the odds of a recession are larger in 2023 than in 2022 because central banks will need to take interest rates higher - and potentially even too high - to get on top of elevated inflation which could cause the downturn,” Ms Mousina said.

“This means that the next few months could see more downside in share markets, until inflation moderates and the growth outlook stabilises.”

Speaking Tuesday on monetary policy and inflationary expectations, Reserve Bank Governor Dr Philip Lowe played the notion of an Australian recession with a straight bat, claiming he doesn’t see a recession on the horizon.

“But if the last two years have taught us anything, you can’t rule anything out,” Dr Lowe said.

This would mean two recessions in three years, as Australia in 2020 experienced its worst single quarterly economic contraction since the 1930s Great Depression.

Fresh after the RBA's first cash rate hike in more than 11 years, Macquarie Bank global strategist Viktor Shvets forecast this to be an emerging theme over the next few years.

He said central banks around the world will "oscillate" between tight and loose monetary policy as they battle inflation and slow economic growth.

More recently, CommBank also said the RBA could start cutting the cash rate again from 2023 as its effects are realised sooner than expected.

‘Small’ pains to avoid a spiral

With inflation tipped by the man himself to reach 7% by year's end, Dr Lowe believes wage growth needs to remain at 3.5% to eventually return inflation to the RBA’s target band of 2-3%.

This comes after the Fair Work Commission recommended a 5.2% increase to the minimum wage and a 4.6% increase to the modern award minimum wage, effective 1 July.

In essence, the RBA Governor is insisting on a real wage cut for most workers in the short term to avoid a greater wage-inflation doomsday spiral.

“If wage increases become common in the 4 and 5 per cent range, it's going to be harder to return inflation to 2.5% and then we'd be in a world where the economy would have to slow more and perhaps the unemployment rate would need to rise,” Dr Lowe said.

“3.5% is kind of the anchoring point that I want people to keep in mind and I know it's difficult when inflation is higher than that, but, in the 1970s, we got into trouble because wages growth responded mechanically to the higher inflation rate.”

Swinging from the hip, the Australian Council of Trade Union Secretary Sally McManus told ABC RN workers' share of the overall GDP is at the lowest level since the 1960s.

“Effectively, there is lots of money and wealth in our country, it’s just that working people are not sharing in it,” Ms McManus said.

“The 1970s price spiral is a total boomer fantasy, it’s then used by employers to say workers can’t have pay increases.

“I look forward to the day when people start calling for caps on profits until inflation is under control.”

Too much juice?

A lot of people will hear the 'r' word and have the early 90s in their head, according to Steven Hamilton, George Washington University's Assistant Professor of Economics.

"Think mass unemployment, shop fronts closed all over the country, but that's not really what is going on," Mr Hamilton told ABC's The World Today.

"The issue is we pumped a lot of money into the economy throughout the pandemic, probably too much and that has run up against a fixed supply constraint in the economy and that is what is pushing up prices."

Hindsight is a dangerous thing, yet Dr Lowe admitted with hindsight there can be an argument made there was too much focus on the downside risks to the economy and the need to insure against them and too little focus on the possibility that things could work out better than expected.

In the words of Lizzo, blame it on the juice.

Read more: Did the RBA overstimulate the economy?

Will the cash rate get to 4%?

The Australian market is pricing the cash rate to be 4% by the end of the year, but Dr Lowe says he will leave it to others to determine if that is reasonable.

“An increase in interest rates of that magnitude, I think, would have a first-order effect on consumption, it would affect people's mortgage payments, it would affect confidence and I think it would slow the economy quite a lot,” Dr Lowe said.

“I don't think it's particularly likely, but the market has been a better judge of where interest rates are going than we have over the past few years, so we've got to pay attention.”

This would send variable mortgage rates realistically into the 6-7-8% territory, which SQM Resarch managing director Louis Christopher said could spell trouble.

A mortgage rate of 7 or 8% would also realistically blow past serviceability assessments on mortgages made in 2020 and 2021, which would be around 6 to 7%.

Image by Jeff Finley via Unsplash