Economy cushioned- but recession likely

New data suggests there is a great risk Australia will follow the world's leading economies into recession in the first six months of next year.

But action by the Reserve Bank and federal government is helping to cushion the economy from the global financial crisis, a key central bank official says.

The Westpac-Melbourne Institute Leading Index of economic activity, released on Wednesday, slumped to an annualised growth rate of just 1.1 per cent in September from 3.5 per cent in August.

The index, which indicates the likely pace of economic activity three to nine months into the future, is well below its long-term trend of 3.9 per cent.

"This is a very disturbing fall," Westpac's chief economist Bill Evans said.

The fall in September was the largest month-to-month percentage point fall since the mid-1980s - greater than in the 1990-91 recession - and points to a very weak growth outlook for at least the first half of 2009.

"It is consistent with Westpac's view that growth in the first half of 2009 will be barely positive with a decent risk that the first two quarters of growth in 2009 could be negative," Mr Evans said.

An economy is deemed to be in recession when it posts two consecutive quarters of negative growth.

However, RBA assistant governor Malcolm Edey said the central bank's decision to cut the official cash rate by 200 basis points since September, the federal government's $10.4 billion fiscal stimulus package and a weak Australian dollar would help soften the impact of the crisis.

"All of these factors will help to cushion the effects of the much more difficult global environment in which we now find ourselves," Mr Edey told delegates at the Australia and Japan Economic Outlook Conference in Sydney.

But Westpac expects the first quarter of 2009 to show negative growth when compared with the final quarter of 2008 because of December's "one-off" boost from the government's fiscal stimulus package.

Pensioners, carers and low-income families are due to get $8.4 billion of the package on December 8 in one-off cash payments.

Last week, the RBA cut its economic growth forecast to just 1.5 per cent by June next year, undercutting Treasury's trimmed 2.0 per cent prediction.

Treasury, however, took the unusual step of including market expectations of further interest rate reductions in its outlook.

Secretary to the Treasury Ken Henry defended the forecast last week after the federal opposition called it "suspicious".

Still, comments by Mr Edey suggest all the argy-bargy that surrounded the forecasts may have been for nothing.

Mr Edey emphasised that any forecasts in the current environment are subject to a great deal of uncertainty.

"Not least because the situation in world financial markets is still changing rapidly," he said.

Most of the recent economic data indicates a slowdown in growth but most were calculated before the start of the latest financial meltdown that followed the collapse of US investment bank giant Lehman Brothers on September 15.

"So they are of limited value in assessing the impact of the latest round of financial turmoil, which dates from mid-September," he said.