Australia heading for its first full-employment recession: Kohler

In just one week, money markets have gone from pricing in a rate increase to a 70% chance of a cut in September. It has been the most dramatic shift in market sentiment in nearly a decade.

In just one week, money markets have gone from pricing in a rate increase to a 70% chance of a cut in September. It has been the most dramatic shift in market sentiment in nearly a decade.

Terry McCrann, writing in the Murdoch tabloids, said last week that a rate cut in September is now “certain” – perhaps even by 0.5%. That would be justified and prudent, in my view, but it would be an amazing event if “rear-view” inflation and unemployment were both still between 4% and 4.5%.

On the other hand, if the Reserve Bank is still targeting the unemployment rate and worrying that labour market tightness will lead to persistent inflation, it will soon have to stop it.

The workplace has changed completely since the last recession – especially in retailing. These days many retail workers don’t have jobs; they have shifts. When business is slow they get fewer shifts. They are still officially employed, but they make a lot less money.

The same goes for Australia’s army of contractors and café operators.

Starbucks’ announcement last month that it is closing 61 of its 84 Australian stores is a sign of things to come for cafes. But it’s not just closures that will be the problem. As coffee consumption falls, café incomes will be crimped, staff will get fewer shifts and owners will have to cut back spending elsewhere.

And while the lower end of the workplace is having their shifts cut back, the top end is copping bonus shrinkage.

Those whose bonuses are tied to share prices are already in trouble; those who have got used to nice annual bonuses based on sales and profit growth have got a pay cut coming.

And the other big change since the last recession is the level of aggregate household debt.

At the individual level this means that many people with variable incomes – contractors, casual retail workers, café owners, executives on low bases and high bonuses – have geared themselves to peak incomes because they thought it would last forever (or else they didn’t really think about it).

As those incomes fall, even though they still have a job, desperation will set in. The cutback in non-essential spending from the new working poor will be more dramatic than we have ever seen.

As a result we could be in for the first full employment recession in history as demand and output contract while everyone, apparently, still has a job.

This will be an incredibly challenging time for RBA governor Glenn Stevens and his board, and will require great flexibility.

The first sign of that flexibility will probably come with tomorrow’s statement accompanying the decision not to change rates.

Will the first cut happen in September? Maybe, but not certainly.

In my view the cash rate will need to be around 5% this time next year, possibly in the 4s, so the governor will need to get started soon if he is not to have rates too tight during a recession and so worsen it.

This article first appeared in Business Spectator