Will coronavirus cause a recession?
The fallout from COVID-19 has led people to wonder what’s in store for the global economy and are we headed for a recession?
The last major global recession happened in 2008, commonly referred to as the ‘Great Recession’ which saw some of the worst unemployment rates and GDP since World War II. While Australia was affected with the local stock market losing 59 per cent and unemployment rising, it was the only developed country to avoid technical recession.
What is a recession?
A recession is commonly described as a prolonged period of reduced economic activity, usually a fall in GDP in two successive quarters. Often, specific spark a recession and a common factor is a sudden decrease in overall economic activity.
Why are people wondering if there is a recession looming?
With the economy already weakened following the bushfires earlier in the year, the impact of the coronavirus on the Australian economy is looking to be significant. This is also the case globally as developed markets prepare for an economic slowdown.
Sectors such as education, hospitality, retail, tourism and entertainment will be mostly affected because of restrictions imposed on gatherings, some universities and private schools moving to virtual classrooms and restrictions on travel.
How have central banks responded to the crisis?
Central banks have reacted rapidly to the crisis, with the Reserve Bank of Australia reducing interest rates to 0.25%. The US Federal Reserve (Fed) Bank of England, Canada and China have also experienced rate cuts.
A challenge that will arise is to provide funding to businesses whose cash flow has been impacted by the virus, particularly in sectors such as transport, hotels, restaurants and other services where demand has collapsed. The danger is that a temporary shock will have permanent effects as businesses go under and close during the crisis. Such a development would damage the supply side and the ability of the economy to recover after the event.
In response, the Australia government is injecting $189 billion into the economy which includes a $17.6 billion economic plan to help reduce job losses and support small to medium sized businesses.
So, how likely is a recession in Australia?
Simon Stevenson, Deputy Head of Multi-Asset Schroders Australia says:
“Left alone, the Australian economy will go into recession. Whether a recession occurs really depends on the size of the fiscal response from the Australian government. The Global Financial Crisis is a good example of a very large fiscal response that resulted in Australia managing to avoid a recession, while other developed economies did not. This showed that fiscal responses can be effective. Given the size and nature of the COVID-19 shock, this fiscal response will need to be very large to have the desired effect.”
What would a recession mean for my finances?
The economy and markets are complex and continuously evolving. There is no one absolute way that a recession occurs, and there would be various implications.
The effects on personal finances would depend on each person’s situation. It’s also important to note that even though there might be some historical trends we can reflect upon, this does not necessarily mean we can refer to history as if we have a crystal ball for future events.
With that being said, the following are some common developments during a recession:
Global stock markets and GDP (Gross Domestic Product) fall
When global stock markets and Gross Domestic Product – an estimate of the total monetary value of a country’s goods and services - fall, invested assets often also decrease.
During the worst phases of the most recent crisis in 2008, the Australian stock market lost more than half of its value, as measured by the S&P ASX200. This wiped out billions of dollars in retirement assets retirement accounts. World, US and Asia (excluding Japan) indices all fell by more than 40%, while the UK lost over 35% of its value.
Reduction in available credit
Banks could also reduce their lending activity, which can decrease the available credit consumers and businesses can access. For consumers, this could in turn reduce spending on everything from homes to cars or holidays.
Business revenue and investments decrease
When consumers stop spending, it also may affect business revenues. When revenues are down, businesses start to focus on cost savings and may halt investments in their workforce and development. Reduced employment levels, stagnant wages and pay freezes could occur.
How can you prepare for a recession?
Recessions can be an intimidating time. The recovery and market reactions could either be a steep climb out over a short period of time or a gradual walk out over the course of years.
It’s not easy to plan for a major economic event and have a set crisis response to something that is widely unknown until after it hits.
We’ve put together five sensible steps to consider to protect your investments which you can find here.
We recommend you speak with your financial adviser if you have concerns or are looking to make changes to your investment portfolio.
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- How COVID-19 is impacting the Australian equity market
- Perspective in turbulent times - Australian Equities
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