Up to 80 Percent Chance Recession Could Occur, Cash Rate to Peak at 4.8 Percent: RBA Internal Research

Pedestrians move past a billboard along George Street in Sydney, Australia on Oct. 18, 2022. (Lisa Maree Williams/Getty Images)

The probability of a recession in Australia occurring before the end of 2024 could be as high as 80 percent, according to modelling by the Reserve Bank of Australia (RBA).

Internal documents from September 2022 published on Thursday under Freedom of Information laws reveal the most likely period for a recession has already passed.

In a more optimistic model, returning Australia’s inflation rate back to the inflation target of two to three percent would come with a 50 percent chance of avoiding recession—what the RBA calls the “narrow path.”

But as the second simulation has Australia’s inflation rate remaining above the inflation target around 30 to 40 percent of the time, the raw probability of a recession falls to around one-third.

“This is much higher than the baseline historical probability of recession of five percent observed in the quarters used for sampling (1998-2019) and 13 percent of all quarters for which we have historical Australian data,” the documents said.

Meanwhile, a model using historical inflationary periods places the chance of recession by 2024 at about 65 to 80 percent.

This model generates a much higher probability because it is “less anchored in central forecasts,” accounts for economic downturns in the United States, and uses more information from previous domestic recessionary periods.

A trader works on the floor of the New York Stock Exchange before in this file photo. (Mario Tama/Getty Images)

Fighting Inflation While Avoiding Recession

A recession is defined as two consecutive quarters of negative real GDP growth. However, the RBA also considers the Sahm rule, which is where the quarterly unemployment rate increases by 0.75 percentage points above the lowest point in the last 12 months.

The Sahm rule is able to identify more mild recessions and would suggest that Australia has experienced more recessions than under the technical definition, such as the dot com crash and the global financial crisis.

“A more aggressive path achieving within-target inflation by end-2024 causes a Sahm recession,” an RBA economist said in an email correspondence. “We also find that rapid tightening yields better unemployment and similar inflation outcomes within the forecast horizon relative to a similar path holding rates high for longer.”

It highlighted that a higher cash rate lowers the probability for recession, but that large increases to the cash rate “significantly” raises the risk of recession.

This point is reflected in the slowing of the monetary tightening cycle after September 2022, where the cash rate increases fell to 0.25 percentage points after four months of aggressive 0.5 percentage point hikes. The RBA also briefly paused cash rate changes in April.

Another email reveals that in models for the “front-loaded” 50 basis point increases and the “steady climb” 25 basis point increases, both scenarios ultimately achieved similar outcomes “provided they both reach the same terminal rate.”

“Both cash rate paths peak at 4.8 percent, which achieves within‐target inflation by end‐2024, and brings unemployment closer to the NAIRU [non-accelerating inflation rate of unemployment],” it reads.

In the “front-loaded” path, the cash rate would have peaked this month in May, while the peak for the “steady climb” path will occur in August.

Budget Inflation Concerns

While monetary policy is a major tool to combat inflation, it also needs to work in conjunction with the government’s fiscal policy.

The documents were published after the federal government delivered the 2023-24 budget, which has come under fire for being a cash splash, inflationary budget.

Opposition leader Peter Dutton said Labor’s budget would likely prompt the Reserve Bank to raise interest rates.

He pointed to the impacts of the 1.5 million immigrants coming to Australia over five years in the budget.

“You don’t have any planning for this. Three hundred thousand people a year on average will contribute to the housing crisis and the rental crisis,” he said.

“At a time when we don’t need an inflationary impact, that is going to be a very significant one.”

Truckers have also dished out some criticism after learning that they will soon be hit with higher taxes, including an increase to the Heavy Vehicle Road User Charge tax to six percent a year.

They warn that this will further drive up transportation costs, having an inflationary impact on the wider economy.

“Once again, they’ve targeted the heavy vehicle side of things. Prices of fuel go up, and that means costs to our customers will go up, and that will start the domino effect. Inflation will go up again, and it will slowly creep back up there,” a trucker from Tripodi Transport told 2GB radio on May 11.

But Prime Minister Anthony Albanese has assured the public that the latest round of cost relief for low-income Australians would not fuel inflation.

“We are dealing with a global economic challenge of inflation. So what we did was to provide support to take pressure off people,” he told ABC radio.

“This is a responsible budget which at the same time looks after people.”

Treasurer Jim Chalmers also said that the budget was “carefully calibrated” to ease pressure from households and reduce inflation by 0.75 of a percentage point in 2023-24.

Alfred Bui contributed to this report.