Australian Economy Needs Rate Cuts

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By Chris Shaw

Not only are rate cuts expected in Australia in coming months, but according to the economic outlook indicated by the Westpac Bank – Melbourne Institute Leading Index, they are needed as the outlook for economic growth is falling sharply.

Index figures for June show the likely pace of economic activity in three to nine months time is around 2.0%, well down from the long-term trend rate of 3.9%. The Coincident Index figures show a similar outcome, as annualised growth for June was just 2.4%, which was also well below its long-term trend rate of 3.7%.

As Westpac chief economist Bill Evans points out, the results from the June survey represent the slowest rate of growth since July 2001 and the sharpest fall in the growth rate since 2000. Evans suggests much of the fall can be attributed to recent declines in the Australian equity market, tighter liquidity levels, weak dwelling approvals data and soft US industrial production numbers.

As the Coincident Index has been below trend since February of this year, Evans suggests June quarter economic growth numbers will be quite poor, which strengthens the case for the Reserve Bank of Australia (RBA) to cut rates when it meets early next month.

While the market is generally factoring in a 0.25% cut, the Westpac view is once the decision to bring rates down is made, the first cut should be larger. Westpac says there is a strong case for the initial cut to be 0.5%, given the weakness of Australia’s economic indicators.

Evans also suggests a larger first-up cut would likely be a more effective strategy than delivering two 0.25% cuts in relatively close succession, but regardless of the size of the initial move, the economy now needs rates to be eased significantly.

On Evans’ forecasts, a total of 1.0% in rate cuts should be achieved by early next year before the bank again pauses in the cycle to ensure inflationary pressures are continuing to trend lower. Once that is confirmed, Evans expects further rate cuts as the RBA moves its policy setting to expansionary.

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