Sluggish economy strengthens case for rate cuts

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The case for even lower rates is strengthening, after a recent economic index shows that the Australian economy is stalling.

The Westpac–Melbourne Institute Leading Index, which indicates the likely pace of economic activity three to nine months in the future, declined 0.13% in May, with nearly every component contributing to the decline.

Consumer sentiment posted a large reversal, slumping 11.3% over the month, while the unemployment expectations index rose 3.8%. The month also included negatives commodity prices (–2.1%) and dwelling approvals (–4.4%).

Westpac senior economist, Matthew Hassan says these results are a worrying, considering the Reserve Bank cut the cash rate to 2% in May.

“The Australian economy appears to have suffered a loss of momentum. After a promising start with four months of above-trend reads, the Leading Index growth rate has effectively dropped back to zero in May indicating a more subdued growth pulse in line with long run averages,” he said.

“That still marks an improvement on 2014 which saw the Index stuck firmly in negative territory and an average growth rate of –0.54%. However, the stalling momentum midyear is a concern given the recent reduction in interest rates.”

However, despite the strengthening case for a further cash rate, Hassan says the Reserve Bank is unlikely to act.

“The case for even lower rates is strengthening. That may see the RBA Board shift to an ‘explicit easing bias’ in coming meetings but this is unlikely to be acted on unless there is clear evidence that growth is likely to significantly undershoot the Bank’s forecasts for 2016.”

More likely, according to Hassan, is that the recent evidence of disappointing growth momentum will cast more doubt over prospects of a rate hike in 2016, in favour of keeping rates on hold.

 

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