(Bloomberg) -- Reserve Bank of Australia chief Philip Lowe’s expectation of further interest-rate rises ahead has prompted economists and money markets to narrow the odds of a recession in the $1.5 trillion economy.
There is now a better than one-in-three chance of a slump over the next 12 months, a Bloomberg survey showed, up from one-in-four late last year when Lowe signaled a rate pause was in the offing. In the US, by contrast, recession probability has begun to come down.
The turnaround follows a jump in inflation that unnerved the RBA, prompting a hawkish pivot and for traders to price in four more hikes. That’s one more rate increase than is currently expected for the Federal Reserve.
The following charts set out the gloomier picture unfolding Down Under.
The RBA embarked on its tightening cycle in May — two months after the Fed — and then moved at a more cautious pace. Lowe argued Australia was different to global peers and inflation would ease as supply chains disentangled. The RBA was aiming, the governor said, to bring the economy in for a soft landing.
But then inflation soared to a 32-year high in the final three months of 2022 as prices were buttressed by strong domestic demand. Lowe’s message adjusted as he acknowledged Australia had the same challenges as the rest of the world. In February, he raised rates and delivered a hawkish message — surprising markets after the RBA had considered a pause in December.
“The path between containing inflation and recession becomes narrower the longer central banks delay aggressive action against inflation,” said Stephen Miller, a Sydney-based investment strategist at GSFM. “The RBA’s prevarication through 2022 has meant that path has got much narrower than necessary.”
The RBA was among the first central banks to downshift to quarter-point hikes in October, a time when the Fed was still moving in 75 basis-point increments. Australian unemployment was then near a 50-year low and job vacancies were at record highs and Lowe wanted to preserve some of those gains.
Miller suggests that might have been a better time to push harder with rate hikes, rather than now, when unemployment is rising and the economy shed jobs in the past two reports.
The RBA’s terminal rate is still seen coming in at more than a percentage point lower than for the Fed.
Expectations for more aggressive RBA action come against a deteriorating backdrop, with consumer sentiment slumping to near recessionary levels. By contrast, US consumers have proved more resilient despite the Fed hiking rates by 4.25 points compared with the RBA’s 3.25 points.
The confidence surveys are starting to be “confirmed by increasing anecdotes from some of the corporates,” said Andrew Canobi, director of Australian fixed income at Franklin Templeton Investment Australia in Melbourne.
“One example of course is Domino’s Pizza who are telling us that customers are now switching from getting their pizza delivered to save a few bucks by coming and picking it up.”
Australian Treasurer Jim Chalmers acknowledged the economy is set to slow “considerably,” in an interview with Bloomberg Television, while adding that he expects it will avoid a recession.
“I am optimistic about the future. We have got a lot of things going for us,” he said.
While US mortgage holders tend to borrow over 30-year terms, insulating them from tightening cycles, a majority of Australian borrowers are on variable rate home loans that adjust upwards each time the central bank hikes.
Australia’s housing market is already in a downturn and higher borrowing costs are likely to drive more declines this year.
There’s a further risk from re-pricing of loans that were fixed for 2-3 years at record-low rates during the pandemic. RBA data suggest 23% of all outstanding mortgage debt will be re-priced this year and in some cases borrowing costs will more than double to close to 6%.
While the RBA is relatively sanguine about housing, Eliza Owen, head of research at property consultancy CoreLogic Inc., sees risks on the horizon.
“Australians with fixed-rate loans are about to see a painful adjustment. This is partly the intention of rising rates,” Owen said. “The true test of the market will be over the next 10 months.”
--With assistance from Cynthia Li.
(Updates with Australian treasurer’s comment in 14th paragraph.)
©2023 Bloomberg L.P.
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