Economic outlook firms up: Leading Index

Date: 25.05.2011

Annualised growth rate of the Westpac-Melbourne Institute Leading Index hits 5.3 percent in March

May 25, 2011

Australia’s economy appears to be finding more solid ground, with the annualised growth rate of the Westpac-Melbourne Institute Leading Index hitting 5.3 percent in March.

This is up from the 4.7 percent recorded in February, and well above its long term trend of 3.4 percent.

Meanwhile, the annualised growth rate of the Coincident Index was 2 percent, well below its long term trend of 3.2 percent.

Westpac Chief Economist Bill Evans says the growth rate of the Leading Index appears to be stabilising at a pace above its trend rate.

Over the last six months the growth rate has remained around that 5 percent base which is well above the 3.4 percent trend pace.

"That growth pace is broadly consistent with Westpac's forecast that the Australian economy will be growing at an annualised pace of around 4.5% in the second half of 2011," Evans says.

He says official sector forecasts from the Reserve Bank and Treasury appear to be even more upbeat than Westpac with the Reserve Bank's recent statement on monetary policy implying forecast growth in the second half of 2011 will run at an annualised pace slightly in excess of 5 percent.

"The first half of 2011 will be distorted by the likely contraction in the economy in the first quarter which will be mainly due to a likely drag on the growth rate of nearly 2 ppt’s from the external sector and inventories."

From October 2010 to March 2011 the growth rate of the Leading Index increased from 4.7 percent to 5.3 percent.

The major source of the increased growth rate was the ‘overtime worked’ series which contributed 1.2 ppt's.

Meanwhile, the major offset came from ‘manufacturing materials prices’ whose contribution to the growth rate fell by 0.5 ppt's.

More modest changes came from: all ordinaries index (0.2 ppt's); US industrial production (0.1 ppt's); real money supply (0 ppt's); dwelling approvals (–0.1 ppt's); productivity (–0.1 ppt's); and corporate profits ( –0.2 ppt's).

The level of the Leading Index rose by 1.5 points (or 0.5 percent).

All four monthly components of the Leading Index rose in March - dwelling approvals (up 9.1 percent); real money supply (up 0.5 percent); all ordinaries index (up 0.1 percent); and US industrial production (up 0.8 percent).

Despite the Reserve Bank’s last meeting and Board minutes hinting at a possible rate rise in June, Westpac says market pricing now gives "virtually zero probability" to a rate hike next month.

"While it is reasonable for markets to assume that one month is not critical to a central bank market pricing does not give full certainty to a hike until June next year," Evans says.

"The implication is that markets expect that the Bank, despite it’s very clear rhetoric, is unconvinced about the need to hike and will need to build a stronger case," he says.

Despite market expectations, Evans says Westpac expects a rate move in the "very near term".