Westpac's leading index suggests economic growth could slow sharply later this year

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If the latest Westpac-MI leading index is anything to go by, Australian economic growth looks set to decelerate sharply before the year is out.

The survey’s 6-month annualised deviation-from-trend growth rate, a gauge on the likely pace of economic growth three to nine months ahead, fell from –1.07% in February to –1.53% in March, leaving the index at the lowest level seen since late 2011.

Ouch.

The chart below, supplied by Westpac, reveals the downward, and somewhat concerning, trend seen in recent months.

Sources: Australian Bureau of Statistics, Reserve Bank of Australia, Federal Reserve Bank of St. Louis, and Melbourne Institute of Applied Economic and Social Research.

Although a disappointing result, it’s important to note that a negative figure indicates the likelihood of a growth rate below Australia’s historic norm, not that an actual recession — classified as two consecutive quarters of negative economic growth — will eventuate.

While the result suggests that growth will slow sharply in the second half of the year, Matthew Hassan, senior economist at Westpac, cautions that weakness seen in March is likely to be temporary in nature.

“Some of the causes of the current weakness in the leading index are likely to be transitory,” says Hassan.

“In particular, the index growth rate – a six monthly measure – is still being heavily impacted by the sharp fall in Australian commodity prices in the second half of 2015. Prices have since posted a solid rally and although it remains to be seen how well this will be sustained, even a pull-back that left prices flat overall would see the drag on the index from this component ease.”

He also notes that much of the weakness in March primarily reflected international factors, rather than domestic.

“The most sizeable subtraction from growth was from US industrial production. The other international component, namely commodity prices, also weighed considerably on growth.”

Though the decline in the index “continues to point to challenging conditions near term”, Hassan retains the view that the RBA will leave interest rates unchanged, not only in May but throughout the year ahead.

“Although there are significant risks around the outlook we remain comfortable retaining our call that interest rates will remain on hold for the rest of 2016,” he says.

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