Australia | Nov 19 2008
By Chris Shaw
Recent data have indicated the Australian economy is weakening and the trend was confirmed today with the latest Westpac-Melbourne Institute Leading Index suggesting significantly weaker growth lies ahead for the Australian economy.
The index, which gives an indication of the pace of economic activity three to nine months into the future, fell to 1.1% in September, well down from the 3.5% growth recorded in August and equally well below its long-term trend of 3.9%. There was no better news from the Coincident Index, as it fell in the month to 1.6% growth in annualised terms, which compares to its long-term trend rate of 3.6%.
Westpac chief economist Bill Evans notes the monthly fall in the index is the largest since the mid-1980s and implies weak growth through the first half of 2009, an outcome that would be in line with the bank’s forecast of barely positive growth for the half and negative growth in the first quarter.
Lower consumer activity levels will be the major contributor to this weakness, as Evans notes households are dealing with the significant negative wealth impact of lower equity prices and a modest softening in house values. Household wealth will also come under pressure from lower deposit interest rates, rising unemployment and deteriorating jobs growth. This leads Evans to suggest government policy will be crucial in stimulating the economy enough to offset the weaker contribution from households.
The weaker Australian dollar should also assist in this regard, as Evans points out it will boost the incomes of exporters and those industries competing against imports. There will, however, be a margin squeeze on importers given the higher costs associated with a weaker currency.
As well, economic growth should be supported by ongoing investment in the mining industry and commercial construction activity, but as Evans notes, this applies to existing work, as tougher credit conditions mean approvals for new projects are falling considerably.
One likely positive in the second half of 2009, in Evans’s view, is an improvement in the housing construction cycle, driven by a combination of an improvement in affordability for owner occupiers and a pick-up in activity from investors. This should help offset the drag in construction activity Evans expects to emerge in 2010.
The major uncertainty for Australian growth remains the outlook for the global economy, as while the US, Europe and Japan are likely to be in recession for much of 2009, the current tough credit market conditions should at least ease according to Evans. China should also offer some sort of boost in the latter half of 2009, as by that time he expects the recently announced stimulus package will have gained some traction.
Commodity markets should also have recovered to at least some extent by the second half of next year. This should transform Australia’s reliance on Asia into an asset again compared to the liability it is proving to be currently.
In terms of policy implications from the latest index reading, Evans suggests neutral in terms of the level of interest rates in the Australian economy is now around 4.5%, down from his previous estimate of 5.5-6.0%. As a result, Evans expects the Reserve Bank of Australia (RBA) will target neutral rates at its next meeting in early December, which implies a further cut to the cash rate of 0.75%. Over time, Evans sees the low point in the rate cycle being 3.5% or less.