Forget hikes. If this indicator is any guide, there‘s a greater risk the RBA will be cutting rates

Cameron Spencer/Getty ImagesThe growth outlook is dimming, according to this indicator.

  • Australia’s economy grew 3.1% in the year to March, a trend the Reserve Bank of Australia (RBA) thinks will continue over the next couple of years.
  • Westpac’s leading index paints a very different outlook, pointing to the likelihood that growth will slow sharply in the second half of 2018.
  • A growth slowdown will make it difficult to reduced unemployment and boost wage and inflationary pressures. It would also make it difficult to justify rate hikes from the RBA.

Australia’s economy grew 3.1% in the year to March, a trend the Reserve Bank of Australia (RBA) thinks will continue over the next couple of years.

Westpac’s Leading Index, produced in conjunction with the Melbourne Institute, disagrees.

It fell heavily in June, pointing to the likelihood that growth will not only slow over the second half of the year but decline to levels that will make it hard to sustain employment growth, wage pressures and a further reduction in the unemployment rate.

“The six month annualised growth rate in the Westpac–Melbourne Institute Leading Index, which indicates the likely pace of economic activity relative to trend three to nine months into the future, dropped from +0.05% in May to –0.33% in June,” says Bill Evans, Chief Economist at Westpac.

“This is the first below trend reading since September last year and the weakest index growth rate since July 2017.”

As seen in the chart below, the index — creating using a variety of domestic and international leading economic indicators — has now fallen over one full percentage point since the start of 2018.

Westpac

At -0.33%, it suggests annual Australian GDP growth will slow to below 2.5% in the second half of the year, leaving it underneath the 2.75% trend level where unemployment and inflationary pressures are expected to remain stable.

“[The] below trend profile for the remainder of 2018 and 2019 accords with Westpac’s current growth forecasts,” Evans says.

In contrast to the theme seen in the second half of 2017 where the indexes international components were strong while the domestic indicators were weak, Evans says the abrupt decline this year has has been broad-based in nature.

“All components have contributed to this slowdown over the course of 2018,” he says.

“The biggest drags have come from a turnaround in the previously positive contribution from the Westpac-MI Unemployment Expectations Index, reduced support from commodity prices, measured in AUD terms, and a deepening contraction in dwelling approvals.

“The index growth rate has also seen reduced positive contributions from the Westpac Melbourne Institute CSI expectations index, the ASX200 and a turnaround in the yield spread.”

This table from Westpac shows the individual contribution each indicator has made to movements in the leading index.

Westpac

While Evans says further confirmation of the potential slowdown is still required, given the likelihood that growth will undershoot the RBA’s expectations this year and next, he retains the view that official interest rates will remain steady until at least 2020.

“With the RBA expecting growth in 2018 and 2019 to be comfortably above trend, we assess that the Board’s current expectations for policy are still different to Westpac’s views,” he says.

“We continue to expect that the cash rate will remain on hold throughout both 2018 and 2019.”

Want to read a more in-depth view on the trends influencing Australian business and the global economy? BI / Research is designed to help executives and industry leaders understand the major challenges and opportunities for industry, technology, strategy and the economy in the future. Sign up for free at .