The Australian economy is performing strongly at present.
There are widespread job vacancies. Shortages of goods and delivery delays continue, though the holdups are reducing. Yet some economists are talking of a recession ahead. What is the logic?
Inflation has jumped dramatically due to the shortages, excessive government spending during the Covid period, and strong consumer demand. In response the Reserve Bank (RBA) has driven up interest rates to engineer a slowdown, a reduction in demand, so inflation falls.
The RBA’s actions have already started to slow the economy. If it raises rates too far it could cause a major slowdown and the economy could contract, a recession. The RBA needs to walk a fine line – just enough rate increases but not too many. Most likely they will get it right.
The RBA must counteract the politicians’ financial errors. The previous Government distributed more cash than necessary in response to Covid and the new Government is continuing to increase its spending. It’s up to the RBA to squeeze consumers with high rates to slow their spending.
Europe has higher inflation than Australia due to the disruption to its energy supplies caused by the Ukraine War. There is more chance of a “hard landing” and recession there. The US also has greater risk of recession than we do, but it probably won’t happen there either.
Australian investors are being affected by the high interest rates. There is less interest in investment properties. Prices are likely to remain flat until interest rates come down noticeably. There is no rush to buy.
Negative gearing of shares and managed funds may not be a profitable strategy at present. Interest rates are too high, especially on margin loans.
Shares should perform better now that the interest rate uncertainty has reduced. Most big companies have low debt levels so high interest rates shouldn’t worry them greatly. However share price growth will need to be strong to beat the margin loan interest costs.
Investors could switch to stocks with high growth potential, such as new technology companies and green energy conversion businesses. Mining companies may also do well. Some coal miners are trading at extreme low price-to-earning ratios, two to three times annual profit.
Inflation fell from 7.8 per cent in December to 7.0 per in the year to March. For the Quarter inflation was 1.4 per cent, or 5.6 per cent annualised. It’s now clear we are past the inflation peak.
There is a good case for the RBA to leave rates unchanged this week. If they do it will suggest a “soft landing” and more stable outlook ahead.