Farewell economy. It was a good time, not a long time. I suggest the RBA fade Bill Evans who has lost the plot. Australia does not have a wage-push inflation cycle. It will wash through. Stop tightening right now.
The six-month annualised growth rate in the Westpac-Melbourne Institute Leading Index, which indicates the likely pace of economic activity relative to trend three to nine months into the future, fell to –0.36% in August, down from +0.49% in July.
This is the first negative print since the start of the year and the weakest since the delta lockdown hit in 2021. The Leading Index ispointing to a material loss in momentum to a below-trend pace.
We are not surprised to see signs of a slowdown heading into the December quarter: Westpac expects growth in the Australian economy to slow from a robust 1.1% in the September quarter to 0.6% in the December quarter.
We expect growth to slow further in 2023, with a gain of just 1% over the full calendar year. One signal for this will be a further weakening in the Leading Index through the remainder of 2022 and into 2023.
The current loss of momentum reflects a combination of policy tightening, a less supportive global backdrop and a cooling labour market.
The Leading Index growth rate has slowed abruptly from a March peak of 1.73% to –0.36% in August. The 2.09ppt turnaround has been driven by four main components: a sharp narrowing in the yield gap as the RBA’s rapid retightening has hit short term interest rates (contributing –0.75ppts);
a big pull-back in commodity prices, down 20% in the last three months alone in AUD terms (contributing –0.63ppts); moderating gains in aggregate hours worked after a big bounce at the start of the year (contributing –0.43ppts); and slowing growth in US industrial production, a bellwether for global growth (contributing –0.22ppts). Other components have seen more mixed moves since March but remain a drag on the index growth rate overall.
The Reserve Bank Board next meets on October 4.
It has become clear that the Board is determined to contain the current inflation surge. While it is rightly concerned about the large lagged effects that have built up from a rapid tightening in monetary policy, the level of interest rates is still below the Governor’s assessment of neutral.
We think that observation, along with the ongoing sharp increase in global rates, will prompt one final 50bp lift to 2.85% in October. Thereafter it will be prudent to slow the pace of tightening to 25bp increments while still sending a clear signal that the Board is committed to restoring inflation to the policy target level. This process will be assisted by a marked slowdown in the economy in 2023, under the weight of the forces that are already being highlighted by components of the Leading Index.
