THE REALITY OF RECESSION
Mark Lister, 2 December 2022
The Reserve Bank has delivered its bluntest reckoning yet of what it will take to tame inflation - weaker growth, further falls in house prices, higher unemployment and a recession.
While this sounds ominous, keep in mind that it wants to see a downshift in activity, caution amongst consumers and restraint during wage negotiations.
Cranking up interest rates is one way to achieve this, as this takes money out of our pockets and provide an incentive to save, rather than borrow or spend.
However, frightening us with the fear of recession is also a useful tool.
If these strong comments help slow things down, the Reserve Bank might not need to follow through as aggressively as projected.
It now believes the inflation peak is still to come, and sees the annual rate rising to 7.5 per cent in the next two quarters, before slowing next year and falling back into the target band of 1-3 per cent in late 2024.
That's in contrast to the local bank economists, whose forecasts all suggest the peak is behind us and that inflation will slow more rapidly than the Reserve Bank is projecting.
It’s also forecasting an outright recession, which is not something you see every day from a central bank.
Again, the local economic community isn't quite as negative.
At the time of the Reserve Bank release, only one bank had a recession in its numbers with the other three in the "very slow growth" camp.
The Reserve Bank projections suggest a shallow downturn, rather than a severe one like the GFC in 2008 and 2009 or the recession of 1990 and 1991.
It sees the unemployment rate hitting 5.3 per cent in the next 18 months. That’s a hefty increase from the current 3.3 per cent, but it’s well below the 6.6 per cent it reached during the GFC or the 10.9 per cent high of September 1991.
Having said that, pointing out that “we’ve seen worse” will be cold comfort anyone who loses their job next year.
Indeed, the Reserve Bank has a difficult needle to thread. It will be a challenge to get inflation under control without pushing unemployment up, or denting the economy.
This doesn’t mean we should panic.
The Reserve Bank’s forecasts might be wrong, just like they were when it came to seeing the inflation risks ahead.
It’s also possible Adrian Orr’s tough talk works, and we cool our jets as he’s hoping.
Oil prices have fallen to the lowest levels of the year, the NZ dollar has rebounded more than ten per cent in the past six weeks (which helps limit imported inflation) and supply chain pressures continue to ease.
That could all help take the edge off inflation in the months ahead.
Even if we do face a recession next year, it will probably be one of the milder ones in our history.
Recessions usually lead to a weaker labour market, lower consumer confidence and a decline in spending. This feeds into softer activity, pressuring corporate earnings and creating a headwind for share prices.
The best defence for investors is to hold a little more cash than usual, take advantage of the current opportunities in fixed income, and ensure share portfolios are well diversified with a tilt to the defensive, resilient sectors that generate reliable dividend income.
For long-term investors (as well as prospective homeowners) such periods can bring as many opportunities as they do challenges.