Surprise surge in Leading Index

By: Graham Gardiner


The annualised growth rate of the Westpac–Melbourne Institute Leading Index was 6.2 percent in December, well above its long term

The annualised growth rate of the Westpac–Melbourne Institute Leading Index was 6.2 percent in December, well above its long term trend of 2.7 percent.

Indicating the likely pace of economic activity three to nine months into the future, the annualised growth rate of the coincident Index rose to 1.3 percent, but remained below its long term trend of 3 percent.

Westpac Senior Economist Matthew Hassan says the Leading Index continues to point to improvement in growth prospects.

"After hitting an extreme low of –6.9 percent in May, the annualised growth rate in the Leading Index has bounced back to +6.2 percent in December," Hassan says.

"This large swing is not only the fastest reversal since the economy bounced out of recession in the mid 1970's but also puts the growth outlook back on a par with that seen in 2007 at the height of Australia’s resources boom," he says.

Key components

Components contributing to the turnaround include: US industrial production (+3 ppt's); industrial commodity prices (+1.7 ppt's); real corporate profits (+1.7ppt’s); domestic labour market conditions (+1.4 ppt’s); productivity (+1.1 ppt's); the share price index (+0.8 ppt's); and dwelling approvals (+0.7 ppt's).

The only drag continues to come from the real money supply component, which was down 1.3 ppt’s due to tighter credit conditions.

According to Hassan, Westpac is currently forecasting growth in the December quarter of 0.6 percent.

While this is a solid result, it still remains below trend.

Future rate changes

With the Reserve Bank Board next meeting on March 2, the minutes of its February discussion, released yesterday, reveals its surprise decision to leave rates on hold was ‘finely balanced’.

"The Bank’s outlook for a return to trend growth in 2010 and 2011 implies a need for further increases to restore the overnight cash rate to ‘neutral’ which we assess as 4.5 percent," Hassan says.

"Indeed, a key message from the Bank was that the situation no longer required moves at every meeting, i.e. the unwind of ‘emergency’ settings was now over and policy was now in a more normal mode of operation," he says.

"Given the desire to send this signal, we believe the fact that February’s decision was still finely balanced suggests there remains a pressing if not quite urgent need to adjust rates further from current levels."

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