Economy slows – are rate rises working?

The Australian economy’s rate of growth slowed in the final three months of 2007 in what could be the first tangible sign that successive interest rates are having some effect.

Australia’s Gross Domestic Product (GDP) for the final quarter of 2007 grew by 0.6% seasonally adjusted, down from 1% on the previous quarter and below market predictions of 0.8% growth.

That leaves annual GDP growth for 2007 at 3.9%, a rate the Reserve Bank of Australia will still want to see lower, but down from the 4%+ rates we were seeing in the middle of last year.

However, the composition of the GDP result raises questions about whether the decline in growth will be sustained, with household spending still growing strongly on 0.9%. The largest negative contribution came from imports of goods and services, which declined 0.8%.

“More recent data hints at some slowdown in household demand in early 2008, but today’s figures highlight the very high starting point and the extent of the slowdown in domestic demand necessary to cool inflation,” ANZ Bank economist Riki Polygenis says.

Another indicator of consumer demand, new car sales, continued its upward trend of the past year, with a 7.4% increase in sales for the first two months of 2008 according to Federal Chamber of Automotive Industries figures. Some 89,898 new vehicles were sold last month, compared to 83,740 in February last year.

But pointing the other way is the services sector, with the Australian Industry Group–Commonwealth Bank performance of services index showing activity in the sector declined in February. The 1.7 point fall means the index is now sitting on 53.2, just above the 50 point line separating expansion or contraction.

And new jobs advertised increased by a reasonably modest 0.4% in February seasonally adjusted, according to online jobs site Seek. Although new job ads are 33% higher compared to the same time last year, they have risen only 2.8% since November 2007, the smallest quarterly increase in three years.

All this means that while the market has dramatically reduced its view of the likelihood of an interest rate rise in the near future, the outlook is far from certain.

And, of course, we may still see an interest rate rise that has nothing to do with inflation – recent rises in lending costs because of the international credit squeeze could mean non-official rate rises from the banks in the near future.

On the markets today, at 12.25pm the S&P/ASX200 is up 1.1% on yesterday’s close to 5438.2. Diminishing expectations of further rate rises has sent the dollar the other way, with one Australian dollar buying US92.67c, down from US92.85c at yesterday’s close.