This indicator suggests the RBA will have trouble lifting interest rates next year | Business Insider Australia

By 15 October 2017May 31st, 2022Articles

Australia’s Leading Index, released by Westpac in conjunction with the Melbourne Institute, continues to paint a fairly dour outlook for Australia’s economy next year, indicating that growth is likely to be well below the levels forecast by the Reserve Bank of Australia (RBA).

The indices six-month annualised growth rate, a guide as to the likely pace of economic activity looking three to nine months into the future, fell again in September, sliding to -0.21% from -0.16% in August.

At that level, it suggests that Australian economic growth is likely to be 0.21 percentage points below its historic trend, widely perceived to be around 2.75% per annum.


So the index is currently pointing to growth of around 2.5%. Not horrible by any stretch, but hardly stellar either.

In comparison, the RBA is currently forecasting that GDP growth — currently running at 1.8% — will accelerate to 3% by the middle of 2018.

As the name suggests, the index uses leading economic indicators from Australia and overseas to provide an early indication on the performance of the economy in the future.

These include readings on commodity prices, the performance of Australian stocks, changes in the shape of Australia’s bond curve and various economic data indicators.

Bill Evans, Westpac’s Chief Economist, says that much of the deterioration in the index this year has been due to weakness in Australian stocks and steep decline in commodity prices.

“The Leading Index growth rate has slowed from 0.93% above trend in April to 0.21% below trend in September, a deterioration of 1.14 percentage points (ppts),” he says.

“The slowdown has been driven by multiple components including commodity prices (–0.96ppts), the ASX200 (–0.42ppts), the yield spread (–0.19ppts) and US industrial production (–0.15ppts).”

Weakness in those readings has completely offset stronger readings for Australian consumer confidence and labour market indicators.

This table from Westpac shows the impact of movements of individual components on the headline index over the past six months.

While the RBA is looking for growth of 3% plus next year, Evans says that the index is likely to be more reflective of what will be seen on the ground, forecasting that GDP will only expand by 2.5% over the year.

“Constraints on growth next year are likely to centre on a lack lustre consumer who struggles under the weight of weak wages growth, high energy prices and excessive leverage,” he says.

“Conditions in housing markets, particularly in the eastern states, are likely to soften while the residential construction boom will turn down.”

Helping to cement that cautious view, he’s not expecting China’s economy to grow at the rollicking pace seen so far in 2017.

“We are also less euphoric about growth prospects for our major trading partners than seems to be the current consensus,” he says. “We expect China’s growth rate to slow from 6.7% to 6.2% as the authorities step up policies to slow its long running credit boom.”

Given the likelihood that growth will shoot the RBA’s forecasts, Evans maintains the view that rates will not change until 2019 at the earliest.

“The developments in the economy which we anticipate are likely to lead the [RBA] to revise its view and keep rates on hold,” Evans says.