Australia's economic slowdown could be about to get even worse

Rusty Jarrett/Getty Images
  • The RBA recently downgraded its forecasts for Australian economic growth this year. It also acknowledged that downside risks have increased, especially from the downturn in Australia’s housing market.
  • Recent leading economic indicators suggest that risk is already materialising.
  • The Westpac-MI Leading Index fell to -0.43% in January, indicating that Australian GDP growth will slow even further in the months ahead.
  • If replicated in reality, that points to upside risks for unemployment, and downside risks for inflation, later this year.
  • Westpac still sees Australia’s cash rate remaining unchanged both this year and next.

The Reserve Bank of Australia (RBA) recently downgraded its forecasts for Australian economic growth this year.

It also acknowledged that downside risks have increased in recent months, especially from downturn in Australia’s housing market spilling over into other parts of the economy.

“If prices were to fall much further, consumption could be weaker than forecast, which would result in lower GDP growth, higher unemployment and lower inflation than forecast,” the bank said earlier this month.

Based on recent leading economic indicators, those downside risks appear to be already materialising.

According to the latest Westpac-MI Leading Index for January, not only is the slowdown seen in the September quarter set to continue in the months ahead, it may be about to get even worse.

The six-month annualised growth rate in the Westpac Index, designed to track the likely pace of economic activity relative to trend GDP growth looking three to nine months into the future, fell to -0.43% last month, declining further after tumbling to -0.29% in December.

Westpac

Trend GDP growth in Australia is widely regarded as being around 2.75% per annum. That’s the level where unemployment and inflation is expected to remain stable.

The Westpac Leading Index measures the expected deviation from trend GDP growth in the future, and is based upon a variety of leading economic indicators from both home and abroad.

Westpac

So the negative reading in January suggests growth is about to slow sharply compared to what was seen in the first half of 2018, creating upside risks for unemployment, and downside risks for inflation, in the middle of the year.

“Despite some choppiness, the major trend is consistent with our view that growth has slowed from a solid above trend pace to one that is at or below trend going forward,” said Bill Evans, Chief Economist at Westpac.

“Over the eight months from September 2017 to April 2018 the growth rate averaged +0.78%. In the nine months since April the growth rate has averaged only +0.10% – a clear step down.

“Those readings to April were consistent with the strong, above trend momentum in the official growth figures that showed the Australian economy growing at around an annualised pace of 4% in the first half of 2018.

“The September quarter national accounts revealed a marked step down in the growth rate printing only 0.3%, an annualised pace of just above 1%.”

So it’s track record over the past year has been pretty good, a trend that Evans suggests will continue.

“Westpac expects that the growth momentum for the full second half of last year will come in at around 1.5%, well below trend and lower than indicated by the Leading Index but certainly consistent with the step down in average growth over the last eight months,” he says.

“The growth pace in 2019 is expected to fall from the annual rate in 2018 of 2.7% to 2.6%.”

Along with the downside risks recently emphasised by the RBA from falling home prices, Evans says that he expects “a slowdown in jobs
growth and investment spending as both political uncertainty and global volatility weigh on firms’ employment and investment decisions”.

Despite forecasting far slower Australian economic growth this year compared to the RBA, and with increasing downside risks, Evans still expects the RBA cash rate will remain unchanged both this year and next.

“Our current forecasts remain lower than those of the RBA and we therefore expect that, over time, the RBA will further revise down their forecasts,” he says.

“However we do not think that those downward revisions will be sufficient to trigger a rate cut.

“As usual, our forecasts will continue to be reviewed.”

Financial markets continue to bet that the RBA will cut Australia’s cash rate by the middle of next year, a view that is also being adopted by a small-yet-increasing number of market economists.

Australia’s Q4 GDP report will be released on March 6, an unfortunate date given it comes one day after the RBA’s next Board meeting.

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.