Australia | Sep 17 2008
By Rudi Filapek-Vandyck
Westpac economists report the annualised growth rate of the Westpac-Melbourne Institute Leading Index, which indicates the likely pace of economic activity three to nine months into the future, was 3.7% in July, well below its long term trend of 4.2%. The economists label the outcome as “weak”. The annualised growth rate of the Coincident Index was 1.4%, also below its long term trend of 3.6%.
However, say the economists, the story is not as disturbing as their report from last month suggested. Last month growth in the index had slumped to 2%. Taking this as a starting point, today’s update is effectively a medium step upwards with Westpac economists highlighting the July report contains a substantial upward revision in growth in June to 4%. That’s the good news, and one would have to be ultra-bearish to argue otherwise.
However, taking the revised June growth indication as a starting point, economic growth indicators in July have weakened compared with June and are now further away from long term trend.
The reason for the substantial upward revision for June, the economists explain, is the much stronger than expected growth in corporate profits and productivity as indicated in the June quarter national accounts. Whereas profits and productivity had together been contributing a steady 1-1.5 ppt’s to growth in the index this jumped to 3-3.5 ppt’s in April-June following the information update from the national accounts.
In the June quarter the national accounts reported a “stunning” 12% rise in the profits of (non financial) companies. This was understandably driven by a 40% increase in mining profits and a 5% increase in non-mining profits; showing the two parallel forces inside the Australian economy at present.
In contrast profits in the small business (including the farm sector) contracted by 2%.
Westpac comments these developments in the index highlight the puzzle that is the Australian economy. Growth is clearly slowing and even the revised index read is consistent with that message, but the clear dominance of the mining sector softens that message. The economists estimate that without the boost to profits and productivity from the mining sector, growth in the index would only have been around 2% .
Excluding the money supply, which is to a degree being distorted by the credit crisis and the resulting preference by investors to remain liquid, the other five components of the index are contributing minus 0.9% to the index’s growth rate, Westpac reports. These five components are the share price index; dwelling approvals; overtime worked; materials prices and US industrial production.
The Reserve Bank Board next meets on October 7. The economists believe that while the message from the index is not as dire for growth as suggested last month, the slowdown in the Australian economy is nevertheless likely to continue. They point out that events in global financial markets over the last few days are emphasising a likely considerable further tightening in financial conditions.
Taking all this into account, Westpac believes there is a strong case for the Reserve Bank of Australia to deliver a further 0.25% rate cut at the next meeting.
Says Westpac: “Further cuts after that are also likely before the Bank pauses to ensure that the necessary reduction in inflation occurs over the medium term.”