BILL EVANS: No rate hikes in 2018 because Australia's economy will underwhelm

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Australian economic growth looks set to underwhelm in 2018, dashing expectations that the Reserve Bank of Australia (RBA) will hike interest rates for the first time since late 2010.

The latest Westpac-MI Leading Index, a gauge that uses domestic and international indicators to predict the likely pace of Australian economic growth looking three to nine months in the future, fell to -0.19% in August, leaving it in negative territory for a third consecutive month.

At -0.19%, the index suggests that Australian economic growth will come in below 2.75%, widely perceived to be Australia’s current trend rate.

It had been as high as +1.13% in March this year.

Westpac-MI Leading Index. Source: Westpac

To Bill Evans, chief economist at Westpac, the latest reading suggests those looking for GDP growth of 3% or more next year — including the RBA — are likely to be disappointed.

“While the Index only gives us a glimpse of the likely momentum in the first few months of 2018 it currently seems to be more consistent with our view of the likely growth environment next year than the Reserve Bank’s forecast for growth comfortably above trend,” he says.

“Westpac is currently forecasting growth of 2.5% in 2018 compared to the RBA’s 3.25%.”

According to Evans, two of the eight components in the index largely explain the turnaround in Australia’s growth outlook over the past five months: a slide in commodity prices and lower longer-term interest rates both at home and abroad.

“After surging nearly 40% over the second half of 2016, the RBA’s AUD commodity price index has retraced nearly 12% in 2017 to date,” he says.

“Similarly, after widening by over 100 basis points in 2016, the yield gap — the difference between the 90-day bill rate and the 10-year bond rate — has narrowed by about 12 basis points, pointing to more subdued market outlook for economic conditions.”

Of the other six components that make up the index, Evans said the results were more varied, improving in some instances but softening in others.

“On the positive side, the index growth rate has been boosted by dwelling approvals, aggregate monthly hours worked and the Westpac-MI Unemployment Expectations index.

“However, these improvements have been partially offset by a bigger drag from the ASX 200 while other components have been largely unchanged.”

This table from Westpac shows the evolution in the eight series components over the past six months.

Source: Westpac

Despite the mixed performance over this period, and narrow breadth that drove the slide in the headline index, Evans remains of the view that Australian economic growth will remain below trend next year, something that he says will see the RBA keep interest rates unchanged throughout 2018.

“The dominant dynamic that is likely to keep rates on hold will be ongoing weakness in income growth — reflecting weak wages growth and slowing employment — constraining consumers’ capacity to lift spending,” he says, adding that “high household debt levels and ongoing risk aversion will discourage households from further substantial cuts to their savings rates”.

“With macro-prudential policies slowing housing markets, the need to raise interest rates in 2018 seems unnecessary.”

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