Westpac's Leading Index suggests Australian economic growth will weaken later this year

Adam Berry/Getty ImagesIs it a bird? A plane? No, it’s a potential growth slowdown.
  • Australian economic growth accelerated sharply in the March quarter, increasing by 1%, the largest increase since late 2011.
  • The result saw GDP growth lift by 3.1% over the year, above the 2.75% level expected by the Reserve Bank of Australia (RBA).
  • The Westpac-MI Leading Index — an indicator that uses economic data and market movements to predict GDP growth in the future — fell sharply in May, pointing to a slowdown in the economy in the second half of 2018.

Australian economic growth accelerated sharply in the March quarter, increasing by 1% in real terms, the largest increase since late 2011.

Powered by a rebound in exports, government spending and increase in business inventories, it saw GDP growth lift by 3.1% over the year, above the 2.75% level expected by the Reserve Bank of Australia (RBA).

At that pace, if sustained, it should help to lower unemployment and boost wage and inflationary pressures given it is above the 2.75% level regarded as being Australia’s trend growth rate.

The RBA thinks strong, above-trend growth will occur over the next couple of years, helping to explain why it thinks the next move in official interest rates is likely to be higher rather than lower.

However, while it’s forecasting better days ahead, the Westpac-MI Leading Index is pointing to a different outcome.

The six-month annualised growth rate in the index, indicating the likely pace of economic activity relative to trend growth (looking three to nine months into the future based on lead economic indicators both at home and abroad) fell sharply in May, dropping to +0.11% from +0.83% in April.

That suggests that while growth in the second half of the year is likely to be above 2.75%, it’s unlikely to be much faster.

“The index points to slowing growth over the second half of 2018,” says Matthew Hassan, Senior Economist at Westpac.

“The May update is the weakest since September last year, and while the index growth rate still indicates that momentum is running slightly above trend, there has been a clear shift lower in the first half of 2018.”

Hassan says the rebound in GDP growth in the March quarter fits with strength in the leading index in the middle of 2017.

Now, however, it’s signalling that momentum is likely to slow, largely reflecting weakness in the indexes domestic components.

“The leading index growth rate has now slowed 1.31 percentage points (ppts) since peaking at 1.42% in December,” he says.

“Domestic components account for most of the turnaround, with material shifts in every component. On a combined basis, domestic components are now showing a below trend growth pulse for the first time since April last year.”

In contrast, Hassan says the above trend reading on the headline index is now entirely due to continued strength in international components.

He also warns momentum could easily slip below trend levels if the index’s global components start to falter.

This table from Westpac shows the contribution of each individual component to the headline index over the past six months.

Westpac Bank

Given the signals generated from the latest update, Hassan says Australian GDP growth will likely decelerate in the quarters ahead, disappointing the RBA, which is banking on faster economic growth to help lift wage and inflationary pressures.

“Westpac continues to expect growth to moderate from here, to a trend 2.7% over 2018, and a below trend 2.5% in 2019, led by softening domestic drivers but with easing commodity prices in the mix as well,” he says.

“Accordingly, we continue to expect the RBA to keep the cash rate firmly on hold both this year and next.”

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