The economics teams at Goldman Sachs JBWere and Merrill Lynch have slashed their estimates of 2008 and 2009 economic growth for Australia and are now predicting recession, despite forecasts to the contrary from Federal Treasury and the Reserve Bank. Goldman Sachs JBWere were the first to predict that the Australian economy would be in recession in the last two quarters of 2008 in a report in mid October. Now they have updated that report and gone further, telling clients the slump this quarter is deeper and will continue until at least June 2009. Merrill Lynch expresses more optimism though about 2010.

The two see the Federal budget going into deficit, unemployment will rise to 7.5% and the Reserve bank will cut interest rates to a low of 3.5%, a point suggested late last week as well by Macquarie Bank interest rate strategist, Rory Robertson. Goldman Sachs urged Federal treasurer Wayne Swan and the Government to worry less about “protecting the budget surplus” and do more to stimulate aggregate demand in the economy.

Robertson and the two teams now say we will get a 1% cut in interest rates from the Reserve Bank at its meeting next Tuesday, which will take the cuts since September to 3%, a measure of how seriously the RBA views what is happening in the economy. Federal Treasurer Wayne Swan still claims the budget won’t go into deficit: the forecasts reckon it will, and they were supposed by the latest update from the well-connected Access Economics team in Canberra.

Goldman Sachs JBWere’s downgrade follows one in the US from their economics group there for the US on Friday: Goldman Sachs said US GDP was shrinking at a 5 % annual rate in the current quarter and will drop 3% and 1% in the next two quarters. It said in a note sent out to clients over the weekend that US unemployment will reach 9% by this time next year. In contrast the US Fed reckons unemployment will get to 7.6% next year (it’s 6.5% at the moment).

According to Goldman Sachs JBWere:

We have revised down our economic growth forecasts from 2.0% in 2008 and 1.7% in 2009, to 1.8% in 2008 and 1.0% in 2009. The new forecasts incorporate a deeper recession through 2H08 than we first forecast in early October and a shallower recovery path through 2H09.

We have also revised our interest rate forecasts, with the RBA now expected to cut the cash rate to 3.5% by March 2009 (75bp lower than our previous forecast).

The combination of dramatic financial wealth destruction, debilitating tightness in money markets, rapidly slowing credit growth, sharp falls in commodity prices and evidence that Australian house prices are declining led us to formally adopt a recession in Australia as our base line view on 12th October.

Since that time our conviction that Australia is poised for its first recession in 17 years has strengthened.

The reduction in commodity prices by our resource strategy team suggests that Australia’s terms of trade will decline — 20% year on year by end- 2009, sufficient to strip around 3.0% from domestic demand growth.

Meanwhile, Merrill Lynch told its clients today that the economy was worse than it had previously thought:

The Australian economy is being overwhelmed by the global financial crisis and external growth shock, impaired credit markets, collapsing asset prices, and imbalances on the household sector balance sheet. We are downgrading our 2009 GDP forecast to 0.2% (down from 1.7% previously).

We expect the economy to contract on a through the year basis over FY09.

In our view, the very substantial monetary and fiscal policy response and adjustment in the exchange rate will not be sufficient to avoid a recession over 1H2009. Our business cycle analysis and leading indicator frameworks are pointing to a rapid deceleration in domestic demand growth over the next 3-4 quarters. Lead indicators of employment (and income growth) have deteriorated significantly over the past quarter.

Our downgrade to GDP growth covers all components of private demand (household spending, housing and business investment) and export volumes.

Business investment in particular will be negatively impacted by the global recession, the fall in the terms of trade and the tightening in the supply of credit.

Global lead indictors have fallen deep into hard landing territory. ML is forecasting global growth of just 1.5% in 2009, down from 3.4% in 2008.

The commodity price and terms of trade decline in 2009 will sharply reduce gross domestic incomes (both directly and indirectly). The steep decline in asset prices over the past 12 months and need for households to lift savings and de-lever reinforces a very weak outlook for household spending through 2009, despite the cash-flow relief coming from lower interest rates and petrol prices.

We expect the labour market to weaken significantly over the next 12-18 months with employment growth falling to -2.0% by late 2009 and the unemployment rate rising to 7.5%.

The household savings rate is assumed to rise to 3.75% (from 0.9% currently) as de-leveraging intensifies.

We are more optimistic about 2010, with substantial global and domestic policy stimulus expected to support a recovery in growth. We expect GDP growth of 2.2% in 2010, led initially by a cyclical recovery in housing activity and strengthening global growth. W expect the RBA to lower the cash rate to 3.5% by Q1 2009 in response to the global downturn, the deep slump in domestic demand growth and reduced inflation pressures. The main focus of policy over the next 6-9 months will be addressing falling corporate and household income growth, which run the risk of exacerbating the de-leveraging underway in the economy.