As Australia’s resources investment slows more rapidly than expected, economists say the central bank is running out of time to reignite other parts of the economy

June 16, 2013, 3:45 p.m. ET

Economists See Risk of Australian Recession

By JAMES GLYNN And RACHEL PANNETT

GEELONG, Australia—At Oppy’s Bistro in this industrial heartland, bartender Gael Fedley is thousands of miles—both literally and figuratively—from a resources boom that’s led Australia to grow faster than any major developed economy in recent years.

A string of factory closures in the town, around an hour’s drive from the country’s second-biggest city, Melbourne, is having an impact on a once-thriving business. Fewer customers stop by Oppy’s now, while regulars have less money to spend on booze and little cause to celebrate.Towering over the town is a refinery that Royal Dutch Shell RDSB.LN -0.96% PLC wants to sell, while further down the road is a support center for retail chain Target where up to 260 jobs are set to go. For Ms. Fedley, things are likely to get even worse as Ford Motor Co. F -1.35% —the dominant employer in Geelong–plans to stop producing cars in Australia from October 2016 with the loss of up to 1,200 jobs.

“As Ford has cut shifts, reduced hours, bar staff have left and patrons have gone,” said Ms. Fedley, who has worked behind the bar at Oppy’s Bistro for three decades. It would take about three days’ nonstop driving from Geelong to reach the iron-rich soils of the Pilbara in Western Australia state that have made many Australians wealthy in recent times: a wealth that hasn’t spread evenly across the nation.

The town, with a population of around 200,000, is just the kind of manufacturing hub the country’s central bank has been trying to revive by cutting rates seven times since late 2011. In May, the benchmark cash rate was reduced to a record 2.75%, lower even than in the depths of the financial crisis.

However, economists think the central bank is running out of time to reignite other parts of the economy as resources investment slows more rapidly than expected.

Goldman Sachs GS -1.75% said last week there was a one-in-five chance that Australia could tip into recession in the coming year—the first time it has flagged a risk of a contraction since the global financial crisis intensified in 2007. While a 20% risk may not sound too alarming, Goldman Sachs said that only once in the postwar period had a probability higher than this not resulted in a recession in Australia.

Saul Eslake, Australia chief economist at Bank of America Merrill Lynch, also recently warned of the risk of recession, adding that the rise in unemployment in resource-rich Western Australia state over the past year already was “recession-like.”

The most rate-sensitive sectors of the economy, including consumer spending and manufacturing, have been slow to respond to the rate cuts. The chief culprit has been the Australian dollar, which until recently had recorded its longest stretch above parity with the U.S. greenback in three decades, making the nation’s exports less competitive.

Now, Australia’s economy no longer has the crutch of a booming mining sector. Iron ore and coal are the country’s largest exports, but prices of each commodity have tumbled as China’s economy began cooling last year.

Resource companies have shed thousands of workers as mining projects were completed and others scrapped.

“The risk of recession is significant,” said Shane Oliver, Sydney-based chief economist at AMP Capital Investors, one of Australia’s biggest fund managers. “We’re now at the point where the mining investment boom is sliding away and unfortunately the other parts of the economy have not picked up enough to fill the gap.”

A generation of Australians has grown up not knowing the pain of rising unemployment and widespread business failures. The last time the country underwent a recession—commonly defined as two straight quarters of contraction–was in the early 1990s when interest rates were raised to 18% to head off a credit boom. The country’s jobless rate peaked at 11.2%, more than double the current level.

Australia was among the few countries that managed to avoid a sharp downturn even after the collapse of U.S. investment bank Lehman Brothers in 2008, due in part to hefty government stimulus, deep interest-rate cuts and a sharp depreciation in the nation’s currency that made exports more competitive. Heavy spending on infrastructure in China, Australia’s biggest trading partner, also helped.

To be sure, economists think Australia has headroom to avoid a recession, but worry this may be narrowing. Goldman Sachs says a combination of better global growth, lower interest rates and a declining local currency could be enough to keep the economy growing. But it lowered its forecast for economic growth to 1.9% in 2014, from a previous projection of 2.7%.

“I think warning of recession is too much, but there is clearly going to be a pretty significant slowing,” said Alan Oster, Melbourne-based chief economist at National Australia Bank NAB.AU +1.70% .

First-quarter gross domestic product was up 0.6% from the preceding three months and 2.5% from a year earlier as exports of raw materials such as coal and iron ore climbed, government figures showed. But the growth was slightly below economists’ estimates and lower than in recent quarters–sparking warnings that long-term growth was decelerating and boosting bets the central bank would cut rates further to give the economy an added kick.

Recently, contractors servicing the mining industry such as Transfield ServicesTSE.AU -5.00% and Boart Longyear BLY.AU -3.79% have issued profit warnings and announced layoffs as customers like BHP Billiton BLT.LN +1.42% and Rio Tinto reduce their spending, adding to a string of job cuts by big iron-ore and coal mining companies last year.

“I don’t see the economy as strong at all,” said Tony Lopes, a taxi driver in Australia’s biggest city, Sydney. Demand has cooled noticeably in the past three months with fewer customers and shorter fares as firms trim spending amid an uncertain economic climate, said Mr. Lopes, who has been driving cabs for more than two decades.

Still, he’s confident the country can weather any slowdown. “This is a rich country and as long as the miners don’t pack up and go, we’ll be okay.”