The 20 countries that use the euro fell into a mild recession around the turn of the year.

That’s in spite of the fact that international organisations such as the OECD are showing a tendency to move their forecasts slightly higher. Part of the reason for this forecast comes down to central banks’ reaction functions. For while it might seem that central banks will do whatever they can to avoid recessions, the truth is that the cost of recessions is not high at the moment when compared to both prior downturns and the benefits of reducing inflation.

Last week’s GDP revisions from the euro zone showed that the region has actually been in a recession in Q4 2022 and Q1 2023. The US too endured a ‘technical’ recession last year as growth was negative in the first two quarters of the year. Strangely enough, it is the UK that has avoided the ignominy of a technical recession so far when many had seen the country as far more vulnerable than the US and the euro zone. But, of course, there is still time for the UK to sink into the red.

“We also believe that the US and euro zone will endure similar downturns. For we should not forget that the slide in growth last year in Europe, in particular, was a function of the hit to household income arising from the dramatic surge in energy prices. If, as seems likely, we see new recessions, or a continuation of recession later this year, it will be down to the effects of monetary tightening, not high energy prices. As we have pointed out recently, survey data from the likes of the Fed and ECB on firms’ loan demand suggests that higher rates have crumpled demand and, when this happens, recessions are not normally far behind”, said Mr. Steve Barrow, Head of Standard Bank G10 Strategy.

Mr. Steve Barrow said the prospect of recessions may unnerve policymakers and the markets but, in fact, neither should get too het up by the prospect of such downturns for a number of reasons.

First, there is limit ed evidence to suggest that any such downturn will be particularly substantial. The recessions so far have been modest. Euro zone GDP just fell 0.1% in both Q4 last year and Q1 this year while, in the US, the technical two-quarter downturn in the first half of 2022 was not bad enough to make the official adjudicator of recessions in the US, the National Bureau of Economic Research (NBER) label the downturn as an “official” recession. Looking ahead any new, or continued, downturn should also prove quite mild.

A second, related, factor is that prior recessions have not come at a cost of surging unemployment and neither does it seem that any future downturn will have a big cost in terms of employment. Data on vacancies, for instance shows that many countries still have as many, if not more vacancies than unemployed people. Not only does an imperceptible rise in the unemployment rate mean that the human cost of recession is relatively low right now, but it also implies that the hit to public finances will be modest.

The fact that the employment cost of reducing inflation is so low right now means that policymakers will feel emboldened when lifting rates, as opposed to some occasions in the past when they might have felt quite fearful about the employment costs of tight policy. Now clearly we would not take this argument as far as to say that recessions are good, or even to be encouraged, at this stage. Undoubtedly, it is better if policymakers can eliminate inflation without pushing their economies into the red. But if this is not possible – and we don’t think it is – then at least now is not a bad time to suffer such economic weakness.

“What’s more, our sense from policymakers that have announced hikes just recently – particularly the RBA – is that they are more willing to accept recessions if this what it is going to take to get inflation down. Of course, it is possible that inflation starts to behave much better, freeing central banks from such difficult choices. But if it does not – and we suspect it won’t - then we should anticipate that central banks are going to lean to the hawkish side even if, or when, their economies lurch into recession”, said Mr. Steve Barrow.