If you care about the Australian economy you should watch these indicators

Ben Birchall/PA Images via Getty ImagesBen Birchall/PA Images via Getty Images
  • Hardly anyone seems to care about Australian PMI reports.
  • We do as we think they’re a pretty good real-time guide as to what’s happening in the economy.
  • The chart below is as good an excuse as any to take an interest in what they have to say.

Of all the Australian economic indicators out there, the Australian Industry Group’s (Ai Group) monthly PMI reports don’t usually receive much attention from financial markets, especially in comparison to what is seen in other advanced economies.

They often come and go to little fanfare, regardless of the message they’re telling.

Here at Business Insider, we keep a keen interest on the PMIs, especially as they provide the nearest thing to a near-time report card on the health of Australia’s manufacturing, services and construction sectors.

They’ve been weakening for quite some time, just like the broader Australian economy, so we think they’re pretty good lead indicator as to what the official data will tell us in the months ahead.

Well, perhaps this chart from UBS may lead to a bit more interest in the PMIs from now on.

UBS

First, let explain what it is.

Each of the PMIs measure a variety of activity indicators, two of which are changes in new orders and inventory levels. Each is scored in a range of between 0 to 100, with a figure of 50 indicating that levels were unchanged from a month earlier.

If the the reading is above 50 it points to an increase from the prior month, while a sub-50 result indicates a decline. The further away from 50 the reading is, the faster the change is, regardless of the direction.

Got it?

We’ll move on to what the chart is implying then.

UBS has created a new orders to inventories ratio, taking into account the respective size of Australia’s services, construction and manufacturing sectors as a proportion of the Australian economy.

The services sector is massive, accounting for nearly 80% of the economy, while the construction sector is around 17%. The rest is manufacturing.

Based on the results in February, the ratio plunged by the most since at least 2004. It could be even longer but that’s as far back the data series goes.

The decline largely reflects that new orders placed at services firms tanked while at the same time inventory levels grew.

If you think that sounds like an ominous combination, you’d be right.

As the chart shows, the new orders to inventories ratio is a decent lead indicator for Australian GDP growth excluding mining sector capital expenditure — the latter more influenced by global rather than domestic factors — with the plunge recorded in February pointing to a further loss of momentum in the economy ahead.

“Well, after Q4 growth materially disappointed the RBA with a drop to a around a six-year low, the further weakening in January retail sales, February car sales and PMIs — with a record collapse in new orders — suggests Q1 is tracking weaker,” says George Tharenou, Economist at UBS.

UBS is forecasting two 25 basis point rate cuts from the RBA this year — the first in July and again in August — although it admits the risk is now that the RBA may go even sooner.

NOW READ: UH OH — The largest parts of Australia’s economy are going backwards

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