Flood 'shock' to hit Leading Index

Economic growth expected to fall well below trend in the first quarter of 2011 as a result of recent floods

January 27, 2011

Recent floods are expected to have an ongoing impact on the Australian economy, with the annualised growth rate of the Westpac-Melbourne Institute Leading Index continuing to slow.

Reports out today reveal the Index, which indicates the likely pace of economic activity three to nine months into the future, was 3.5 percent in November 2010 – just above its long term trend of 3.2 percent.

The annualised growth rate of the Coincident Index was 3.5 percent.

Westpac’s Chief Economist Bill Evans says the Index is now only slightly above trend, having peaked in the first quarter of 2010.

"We had expected this slowing to be arrested in the coming months pointing to economic growth in 2011 around trend," Evans says.

"However the exogenous shock from the floods will distort the 'around trend' growth profile in 2011 for the Australian economy," he says.

This will see growth fall well below trend in the first quarter and pitch above trend in the second half as the economy receives a boost from the rebuilding program.

In June the annualised growth rate of the Leading Index was 7.4 percent.

Contributors to the 3.9 ppt's slowdown in the growth rate since June include: overtime worked (1.1 ppt's); corporate profits (1 ppt); manufacturing materials prices(1 ppt); productivity (0.7 ppt's); US industrial production (0.5 ppt's) and dwelling approvals (0.4 ppt's).

These were partly offset by the share market which added 0.3 ppt’s and the real money supply (0.6 ppt's).

The level of the Leading Index increased from 278.3 to 278.4 in November, with two of the four monthly components falling and two posting a rise.

The all ordinaries index fell by 1.7 percent while dwelling approvals were down by 4.2 percent.

Increases were registered for US industrial production (up 0.3 percent) and the real money supply (up 0.8 percent).

Three of the quarterly series were down (overtime worked; productivity and corporate profits) while manufacturing materials prices increased.

Meanwhile, the level of the Coincident Index increased from 267 in October to 268.3 in November (up 0.5 percent).

Of the three monthly components of the Composite Index real retail trade was unchanged; employment was up 0.5 percent while the unemployment rate fell back to 5.2 percent.

There are many reasons why the Reserve Bank Board will keep rates on hold when it next meets on February 1, in Evan’s view.

"Firstly, the effects of the rate hike in November and the subsequent larger increase in mortgage rates will not yet be clear," he says.

With rates now above neutral, Evans says more time should be taken between rate moves to assess the impact.

"Secondly, the floods will have a severe impact on economic activity in the first quarter," he says.

Westpac says it does not expect to see the next rate hike until the September quarter.

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