By Michael Yardney September 30, 2024

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Brace Yourself: Is Australia About to Enter a Period of Stagflation?

Michael Yardney's Commentary
Brace Yourself: Is Australia About to Enter a Period of Stagflation?

Key takeaways

Many pessimists predicted that Australia would fall into recession, and while that hasn't happened, Australia is navigating choppy economic waters, which has led to the term "stagflation" surfacing in discussions among economists and commentators.

Stagflation occurs when the economy is going through a tough time, but instead of inflation falling sharply to enable stimulation, other forces keep inflation too high. This leads to stagnant or negative economic growth.

The economic stress isn't spread evenly across the population, with some parts of the population faring much better than others. Yet, the slowdown in consumer spending has now spread beyond those directly impacted by rising mortgage costs.

Despite high interest rates, our property markets are still growing, and some states are outperforming others. For investors with a secure job and a strong financial base, the current market conditions present a unique opportunity to build wealth.

While it's too early to declare that Australia is in a period of stagflation, the warning signs are there.

It wasn’t that long ago that many pessimists were predicting that Australia would fall into recession, and while that hasn’t happened there is no doubt that Australia is navigating choppy economic waters.

This has led to the term "stagflation" surfacing in discussions among economists and commentators.

Stagflation—a rare economic condition characterized by stagnant growth, high unemployment, and persistent inflation—poses a unique challenge because it undermines the effectiveness of traditional economic policy tools.

To understand whether Australia is on the brink of stagflation, let's delve into the key factors at play.

Stagflation: the unlikely trio of economic woes

Stagflation is a scenario that confounds conventional economic wisdom and takes place when the economy is going through a very tough time.

However, instead of the depressed economic conditions causing inflation to fall sharply to enable stimulation, other forces keep inflation too high.

Normally, inflation and unemployment are expected to move inversely; however, stagflation disrupts this balance with simultaneous high inflation and high unemployment alongside stagnant or negative economic growth.

For Australia, the recent economic data is starting to raise red flags that we might be heading down this path.

How did we get here? - a brief recap

Inflation began to rise in Australia around three years ago, after those interest rate cuts, we received to help us through the pandemic and was initially driven by supply chain disruptions, geopolitical tensions, and surging global energy prices after.

In response, the Reserve Bank of Australia (RBA) was initially slow to adjust, keeping interest rates low for too long—a move that some critics argue allowed inflation to gain too much momentum.

When the RBA finally acted, it undertook one of the most aggressive interest rate hikes among Western economies.

This approach was particularly harsh on Australian households, many of whom had taken on significant debt to buy homes during the prolonged period of low interest rates.

The impact of these rate hikes is now evident in the latest economic figures: household consumption per capita has contracted over the past six quarters – meaning we have been in a per capita for quite some time.

Business investment also dipped in the June quarter, and residential construction has remained flat, all signs pointing to a broader economic slowdown.

Inflation stays high: the persistent challenge

One of the critical components of stagflation is persistent inflation that doesn't fall as expected during economic downturns.

Normally, depressed economic conditions would help reduce inflation, allowing for policy easing (including lowering interest rates) to stimulate growth, but this has not occurred despite the slowdown in domestic demand.

The reasons behind this include:

Government spending at both state and federal levels is funded by borrowing.
Skills shortages have pushed up wages.
The federal government has encouraged rage rises across the board, in part to fix the cost of living challenges, but this intern pushed up prices further.
Rising energy costs.
Lack of improved productivity among Australian workers

Obviously, this sticky inflation complicates the RBA's task.

If inflation remains too high, the RBA might continue with its tight monetary policy, which could further dampen economic growth.

However, cutting rates prematurely risks fuelling inflation again, putting the RBA in a tough spot.

Who’s feeling the pinch?

The economic stress isn’t spread evenly across the population.

While about 30% of Australians are experiencing severe mortgage and rent stress due to the combination of high debt levels and rising interest rates, other parts of the population, particularly those with paid-off homes and little to no debt, have been faring much better.

Yet, there’s a worrying trend: the slowdown in consumer spending has now spread beyond those directly impacted by rising mortgage costs.

Even affluent sectors are pulling back on spending, with exceptions primarily in South Australia and Western Australia, which have managed to sidestep some of the broader economic malaise.

What’s next for the Australian economy?

The big question is: will the current mix of high inflation and stagnant growth evolve into full-blown stagflation, or will the economy adjust before the worst-case scenario unfolds?

The RBA's next moves will be crucial.

They need to tread carefully—raising rates again could easily tip the economy into a recession while easing too soon could reignite inflationary pressures.

Government policies aimed at boosting productivity, easing supply bottlenecks, and providing targeted relief to struggling households could help mitigate some of the pressures.

However, these measures will take time to show results, and the road ahead is far from certain.

Implications for property investors

For property investors, this environment underscores the importance of strategic, well-informed decision-making.

Despite high interest rates, our property markets are still growing but remain very fragmented, with some states outperforming others.

For investors with a secure job and a strong financial base, the current market conditions present a unique opportunity.

By taking a long-term view, focusing on high-quality assets, and making strategic purchases while others are hesitant, these investors can build wealth and position themselves for future success.

It's about seeing beyond the immediate challenges and recognising the potential for growth and value creation over the long haul.

Conclusion

While it’s too early to declare that Australia is in a period of stagflation, the warning signs are there.

The RBA and government will need to carefully balance their actions to avoid tipping the economy into deeper trouble.

For now, staying vigilant and adaptable is the best course of action for both policymakers and investors alike.

About Michael Yardney Michael is the founder of Metropole Property Strategists who help their clients grow, protect and pass on their wealth through independent, unbiased property advice and advocacy. He's once again been voted Australia's leading property investment adviser and one of Australia's 50 most influential Thought Leaders. His opinions are regularly featured in the media.