The coming RBA downgrade to growth

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As the debate rages over monetary policy the data continues to paint a picture of a weak domestic economy with a growth profile which is likely to undershoot the forecasts of both the RBA and Treasury over the remainder of 2011 and into 2012, the Westpac leading index was released earlier today and after a significant revision last month following the inclusion of the weak outcomes from the national accounts for Q1, the index continue to slide in May.

While there were no further updates for the quarterly inputs the fall in the 2 of the months inputs which included the all ordinaries (-2.4%) and building approvals (-7.9%) more than offset gains in the money supply (0.6%) and US industrial production (0.1%) leaving the index down 0.1%. The annual pace of the index has now slid to its lowest level since September 2009.

While this points to a weaker outlook for economic growth we were more concerned with the continued fall in the coincident index which has a much closer correlation with the actual GDP outcomes. The fall in retail spending and the stagnant employment market provided the biggest drag on the coincident index which also fell 0.1% in May however the annual rate is now also sitting at -0.1%.

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If we assume that the correlation continues to hold then the annual pace of economic growth will slow from an annual rate of 1% in the first quarter to 0% in Q2. This implies that growth for the quarter will be 0.4% (absent any revision to previous outcomes) replacing the 1.4% increase from Q2 2010.

With exports of coal through the Gladstone Port finally picking up in June, indicating that production is getting back underway in the Bowen Basis, there may be some upside risk to the suggested outcome of 0.4% for the quarter. However for the RBA to reach its current forecast of an annual rate of GDP growth of 2.5% by June 2011, we would need to see a quarterly increase in GDP of 2.9% in Q2 (replacing the 1.4% increase from Q2 2010). Thus we are likely to see the RBA downgrade their growth forecasts when they release their latest Quarterly statement on Monetary policy on August 5.

In the absence of an aberrantly high inflation reading for Q2 released next Thursday a lower growth profile also implies lower inflation forecast, removing the need to raise interest rates any time soon.

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