Westpac: Leading indicators solid

From Westpac and the Melbourne Institute today comes leading indicators for the economy (full report below). And they’re solid:

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 4.7% in February 2011, above its long term trend of 3.3%. The annualised growth rate of the Coincident Index was 2.1%, well below its long term trend of 3.2%.

The level of the Coincident Index rose 0.2% in February. Amongst the three monthly components, real retail trade rose by 0.3% while employment registered a small 0.1% decline. The unemployment rate remained at 5% in February. The Reserve Bank Board next meets on May 3. There is little chance of any change in rates at that meeting despite an inflation report which will be released on April 27. We expect the Reserve Bank’s measure of quarterly underlying inflation to rise from 0.4%qtr, registered last January, to 0.7%qtr in April. That will be consistent with the Bank’s current forecast of around 2.75%yr for 2011. Of much more importance will be wages and employment.

The mining boom and the surge in the terms of trade have given a huge boost to national incomes and the risk is that this boost shows up in rising wages and employment despite a likely increase in the profit share. With the unemployment rate already below the Bank’s assessment of full employment and the lead indicators pointing to ongoing strength in jobs growth the Bank will be most sensitive to labour market pressures. We continue to give a reasonable chance to another rate hike in the September quarter but expect, given the ongoing evidence of a concerned consumer and sluggish housing market, a follow up move will not be necessary until well into 2011.

In short, things are soft now but looking better in six months. I see nothing at this point to gainsay this analysis except on one point. Take a look at a chart of the index graphed against actual growth:

The correlation with growth is very strong except in the very recent cycle where spiking indicators were followed by a subdued bounce in growth. Paradign shift or anomoly?

Westpac Leading Indicators

David Llewellyn-Smith
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