Economic activity to remain below-trend: Report

The Westpac-Melbourne Institute Leading Index fell to 1.6% in June, as the economy grapples with consumer and business caution, higher savings rates and rising unemployment.

The Leading Index indicates the likely pace of economic activity three to nine months into the future, and the June result puts it well below the long-term trend of 3%.

It is also the second consecutive month the index has printed at 1.6% – a sharp decline from the 2.7% printed in April.

Westpac chief economist Bill Evans says weak growth in consumer spending and higher savings rates will contribute to below-trend growth for the rest of the year.

According to Evans, Westpac expects an annualised growth rate of 2.5% in the second half of 2011.

“The growth rate in the index has steadily fallen from its peak in this cycle of 9.5% in March 2010. This is now the lowest growth rate for the index since August 2009,” he says.

Meanwhile, Westpac expects unemployment to rise to 5.5% in the first half of 2012, partially as a result of the mining boom.

“Economic activity is being diverted away from services and manufacturing to mining and mining construction, which are not intensive users of labour,” Evans says.

According to Evans, there is emerging evidence to support his view that the Reserve Bank will cut interest rates by 25 basis points by the end of the year.

“On July 15… Westpac changed its interest rate forecast to incorporate 100 basis points of rate cuts by the Reserve Bank, beginning with 25 basis points in December,” he says.

“Despite extraordinary fluctuations in market pricing, we are comfortable to maintain that view while recognising that a continuation of the global market uncertainty could force the RBA’s hands to cut rates a little earlier than our original December target.”

The RBA and the Federal Government are concerned Australians may be psyching themselves into an economic downturn in the wake of renewed financial turmoil.

In the minutes of its latest board meeting, the RBA said the danger of both households and businesses losing confidence was the main reason it was keeping interest rates on hold.

“If the financial market turmoil continued, it could further weaken household and business confidence. This in turn could weaken the outlook for demand relative to the central forecast,” the minutes said.

Treasurer Wayne Swan has called on the public to stay confident, saying that while he did not underestimate the “extreme seriousness” of global economic conditions, Australia was in a much stronger position than in 2008 when the global financial crisis hit.

“Australia faces the current turmoil from a position of genuine strength. Our banks have confirmed they are very well advanced in meeting their funding requirements and could go a long period without needing to raise money offshore,” he said.