ARE WE HEADED FOR RECESSION?
Mark Lister, 23 June 2022
I won’t go as far as suggesting a recession is inevitable, but let’s just say it’s going to be difficult to avoid.
Here in New Zealand, March quarter gross domestic product was weaker than expected, with the economy contracting 0.2 per cent.
That puts us at risk of entering a "technical recession", which is generally thought of as two consecutive quarters where the economy goes backwards.
I don't think that'll happen. The March quarter was impacted by the Omicron-related disruption, and a rebound is likely in the June quarter.
Having said that, I suspect there is further weakness to come as higher mortgage rates, falling house prices and lower activity start to bite. It’s later this year and early next year that worries me, rather than today.
The situation in the US isn’t dissimilar. A near-term recession is unlikely, especially while unemployment as low as it is, but fast forward six to 12 months and the backdrop could look quite different.
Like our Reserve Bank, the US Federal Reserve is cranking up interest rates aggressively, trying to get in front of the inflation freight train and slow it down.
To succeed, both central banks will almost certainly need to create a bit of labour market slack, which is economist-speak for a modest rise in unemployment.
Considering there hasn’t been a time in the last 75 years where the US unemployment rate has risen more than 0.5 per cent without a recession occurring, that’ll be a tricky needle to thread.
The US unemployment rate is 3.6 per cent, close to a 50-year low, while ours is 3.2 per cent, the lowest since the early 1980s. That’s close to full employment, and well above maximum sustainable employment.
That’s a key piece of the inflation puzzle, as it raises the risk of the dreaded wage-price spiral, something notoriously difficult to reverse when it takes hold.
Both central banks have forecasts that show policy interest rates doubling from current levels, and inflation eventually playing ball and falling back into the sweet spot.
These projections also reflect progressively weaker labour markets. Fed forecasts point to an unemployment rate as high as 4.1 per cent in 2023, while our Reserve Bank sees it increasing to 4.4 per cent by the end of next year.
To be blunt, central banks are unlikely to get inflation under control without pushing unemployment up, and that’s going to be difficult to achieve without causing a recession of some magnitude.
This doesn’t mean we should panic. Not all recessions are like the GFC, and many feel more like a slowdown rather than something more sinister.
They can also be necessary, especially after a period of such exuberance across some sectors of the economy, while opportunities always emerge in the wake of such resets.
What it does mean is that we should prepare for more expensive mortgages, as interest rates keep rising over the balance of the year.
That tends to be a headwind for asset values, so falling house prices and lower KiwiSaver balances could be par for the course. For those who are buyers rather than sellers, that will bring as many opportunities as it does challenges.
We might also start to hear more about job losses in the months ahead, and we might know a few people who’ve become casualties of the fight against inflation.
A recession would also mean we’re facing a much more interesting political backdrop heading into 2023. No government of the MMP-era has had less than three terms in power, although recessions didn’t tend to be particularly friendly to the incumbent regime.
Don’t be fooled by euphemisms. The central banks probably won’t say it outright, but if they are going to win the war against rising prices, they’ll need to sacrifice some growth and jobs along the way.