Odds increase for a 2027 Australian recession

Recent analysis suggests the odds of an Australian recession in 2027 have increased, driven by several factors. Australia's economy has performed poorly per capita compared to its peers in the OECD, with GDP per capita dropping by 0.3% between the second quarters of 2022 and 2026. However, Australia's strong population growth due to immigration has kept the country from a technical recession, which is currently prevented by this population growth.

But, the odds of a recession in 2027 have risen due to Australia's heavy reliance on diesel, the cost of which has surged due to the Middle East conflict. This could cause fuel shortages in critical industries like freight, mining, and agriculture, potentially resulting in a contraction of output. Even if such shortages are avoided, higher fuel costs are expected to lead to cost-push inflation across the economy, as firms pass on the increased expenses.

The Reserve Bank of Australia is more likely to raise interest rates in response, which could further damage the housing market and reduce economic growth. Financial markets have already priced in two more rate hikes, with a strong likelihood of a third, bringing the interest rate to around 5.10%.

HSBC chief economist Paul Bloxham warns that Australia's housing downturn will negatively impact consumer spending and GDP by 1%. The housing downturn is expected to lead to a 13% peak-to-trough decline in capital city home values, which will affect the economy through four channels: consumer spending, housing turnover, state revenues, and construction activity.

Empirical model estimates suggest that a 5% decline in housing prices typically reduces consumer spending by 0.8% over two years, with about half of the effect occurring in just two quarters. A 13% peak-to-trough housing price decline could result in a 0.4% less GDP in two quarters, and 1% less GDP over time. Furthermore, falling housing prices typically lead to less housing turnover, resulting in fewer durable goods purchases by households, another component of the negative wealth effect.

Other factors influencing the potential recession include the fall in stamp duty revenues due to reduced housing turnover, which could constrain state government spending. Additionally, falling housing prices make it harder to profitably build dwellings, as construction costs rise alongside housing prices. This has been seen in the past, with the 2017-19 housing price decline coinciding with an 18% contraction in residential investment.

Thus, Australia's economy faces a perfect storm of factors that could pull it into a technical recession next year, alongside a deep per capita recession. These factors include rising fuel prices and potential shortages, rising interest rates, and an accelerating housing downturn.