Australian economic growth could be about to take off

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The global economy is picking up steam, and it looks like the Australian economy is following suit.

However, don’t get too excited, it’s unlikely to last.

That’s the mixed message from the latest Westpac-MI Leading Index released today, which jumped to the highest level in over a year in December, pointing to the likelihood that economic growth with accelerate sharply in the first half of 2018.

The index’s six-month annualised growth rate, a guide to the likely pace of economic activity looking three to nine months into the future, rose to 1.41% from 0.66% in November.

At that level, it suggests Australian economic growth is likely to be 1.41 percentage points above its trend level, widely perceived to be around 2.75% per annumm.

That means growth, according to this measure, could accelerate to well in excess of 3%, perhaps even more.

“This is a very strong above trend reading and, following the solid results in October and November, points to solid above trend growth in the early part of 2018,” said Bill Evans, Chief Economist at Westpac.

“The index has recovered from the slow patch in June and August, and, for this month at least, is above the levels it enjoyed over the six months to May when the average growth rate reading was a solid +1.12%.”

As shown in the chart below from Westpac, the index has surged from –0.06% in July to +1.41% in December.

Source: Westpac

Helping to explain the sharp and sudden turnaround, Evans said that seven of the index’s eight sub-indices improved in December, led by surging commodity prices.

“The main component contributions to the lift over this period have been commodity prices in AUD terms, dwelling approvals, the Westpac-MI Consumer Sentiment expectations Index, the Westpac-MI Unemployment Expectations Index, a steeper yield curve, the ASX 200 Index as well as US industrial production,” says Evans.

“Only aggregate monthly hours worked detracted from growth over the period.

“The boost to growth shows a healthy mix of both international and domestic factors providing further confidence around the near term outlook.”

This table from Westpac shows the movements in individual components going back six months.

Source: Westpac

So, based off the December result, it looks like it’s time to pop the champagne.

Growth is about to accelerate sharply, providing the ideal platform for the Reserve Bank of Australia (RBA) to begin lifting interest rates given its implications for employment growth, inflation and wage pressures.

Not so fast, says Evans. The champagne is best kept on ice.

“Markets and most commentators, partly reflecting signals like the current reading of the index, are expecting rates to start increasing in the second half of 2018,” he says.

“In our view, there are still key negatives around housing, household incomes and the consumer which are likely to challenge the sustainability of any upswing in 2018.”

Rather than forecasting one or more rate hikes from the RBA this year, Evans says they will likely remain on hold until at least 2020 given the prospect that inflationary pressures remain subdued.

“The bank’s own underlying inflation forecasts are currently 1.75% in 2018 and 2% in 2019,” he says, adding that “it expects wages growth to increase gradually over the next year”.

Based on those forecasts and the likelihood that any boost in growth will be temporary, Evans says the “prospects for an imminent rate move are very small”.

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